Abstract
Abstract The authors investigate the desirability of income taxes when the objective is to mitigate wasteful conspicuous consumption generated by people's status-seeking behavior. They consider the joint role of pre-tax wage inequality and of social norms determining how social status is assigned. They find that when social status is ordinal (i.e., only one's rank in the income distribution matters) inequality and taxation are substitutes. Instead, when status is cardinal (i.e., also the shape of the income distribution matters) inequality and taxation can be complements, although the relationship is in general non-monotonic. This is because the value of social status is endogenous, potentially giving rise to a perverse selfreinforcing mechanism where more waste in conspicuous consumption induces a greater competition for status and vice versa.
Highlights
When people care about their relative standing in society the labor market is likely to produce inefficient outcomes (Frank, 2005, 2008)
Under cardinal status the value of status is intrinsically endogenous so that conspicuous consumption indirectly affects the value of status by affecting the choice of how much to work. This potentially gives rise to a vicious cycle: more conspicuous consumption leads to more income which in turn asks for more conspicuous consumption. These results suggest that any policy relying on an income tax which aims at mitigating wasteful conspicuous consumption should carefully consider what is the pre-tax wage inequality and what are ruling social norms that determine status
In this paper we have investigated the impact of labor income taxes when agents can signal their relative standing by spending on a conspicuous good
Summary
When people care about their relative standing in society the labor market is likely to produce inefficient outcomes (Frank, 2005, 2008). The main finding here is that, when status is ordinal, labor income taxes and wage inequality are substitutes in mitigating wasteful conspicuous consumption. In the second part of the paper, we analyze the consequences of a labor income tax when status is not ordinal but cardinal – i.e., when people care about how far other people are in the distribution of incomes. This potentially gives rise to a vicious cycle: more conspicuous consumption leads to more income which in turn asks for more conspicuous consumption Overall, these results suggest that any policy relying on an income tax which aims at mitigating wasteful conspicuous consumption should carefully consider what is the pre-tax wage inequality and what are ruling social norms that determine status.
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