Social Welfare Weights Research Articles

Generalized Social Marginal Welfare Weights Imply Inconsistent Comparisons of Tax Policies

This paper concerns Saez and Stantcheva’s (2016) generalized social marginal welfare weights, which aggregate losses and gains due to tax policies while incorporating nonutilitarian ethical considerations. The approach evaluates local tax changes without a global social objective. I show that local tax policy comparisons implicitly entail global comparisons. Moreover, whenever welfare weights do not have a utilitarian structure, these implied global comparisons are inconsistent. I argue that broader ethical values cannot in general be represented simply by modifying the weights placed on benefits to different people, and a more thoroughgoing modification of the utilitarian approach is required. (JEL D60, D63, D71, H21, H23, I31)

Optimal Taxation of Capital Income with Heterogeneous Rates of Return

Abstract We derive the Pareto-efficient mix of non-linear taxes on labour income and capital income if people differ in their rates of return on capital. We allow for two reasons why rates of return differ: because individuals with higher ability are better able to invest their capital or because wealthier individuals enjoy scale effects in wealth accumulation. In both cases, a strictly positive tax on capital income is part of any Pareto-efficient tax system. We derive a condition for the Pareto-efficient tax mix that relies solely on empirical sufficient statistics – not on social welfare weights – and find that Pareto-efficient taxes on capital income increase with the degree of return heterogeneity. Numerical simulations for empirically plausible return heterogeneity suggest that Pareto-efficient marginal tax rates on capital income are positive and substantial.

Summaries of Articles

Summaries of Articles

Supply-side optimal capital taxation with endogenous wage inequality

In a model with a continuum of imperfectly substitutable laborers and endogenous skill premiums, this paper derives optimal tax formulas as functions of social welfare weights and a small set of estimable statistics. It first demonstrates that differential capital tax, based on capital’s effect on skill premiums, is desirable even in the steady state, while nonlinear capital tax is not desirable under an additively separable utility function. It then explores both uniform and sector-specific capital income tax (UCIT and SCIT), with a sector corresponding to a type of laborer. Numerical application to U.S. taxation delivers an inverted U-shaped relationship between the SCIT rate and sectoral wage. The optimal SCIT rate on the top-income sectors increases with the elasticity of substitution between the sectoral products and amounts to a net return tax of 45.9%. Reform from UCIT to SCIT compresses wage gaps between the top ten percent and others considerably. It especially favors the median-income individuals whose wages are increased as high as 3.8%. Due to production inefficiency, switching from UCIT to SCIT implies small welfare gains (0.07%~0.22% in consumption-equivalent terms).

Supply-side Optimal Capital Taxation with Endogenous Wage Inequality

In a model with a continuum of imperfectly substitutable laborers and endogenous skill premiums, this paper derives optimal tax formulas as functions of social welfare weights and a small set of estimable statistics. It first demonstrates that differential capital tax, based on capital's effect on skill premiums, is desirable even in the steady state, while nonlinear capital tax is not desirable under an additively separable utility function. It then explores both uniform and sector-specific capital income tax (UCIT and SCIT), with a sector corresponding to a type of laborer. Numerical application to U.S. taxation delivers an inverted U-shaped relationship between the SCIT rate and sectoral wage. The optimal SCIT rate on the top-income sectors increases with the elasticity of substitution between the sectoral products and amounts to a net return tax of 45.9%. Reform from UCIT to SCIT compresses wage gaps between the top ten percent and others considerably. It especially favors the median-income individuals whose wages are increased as high as 3.8%. Due to production inefficiency, switching from UCIT to SCIT implies small welfare gains (0.07%∼0.22% in consumption-equivalent terms).

Dynamic Pre-distributive Capital Tax Design with Raising Skill Premium

This paper studies optimal dynamic capital taxation under the progress of skill-biased technologyand finds a novel reason for taxing capital. We demonstrate that the optimal capital tax rate can be expressed as a function of time-invariable social welfare weights and a time-variable (a) skill premium,(b) utility elasticity of labor, and (c) Hicks elasticity of complementarity between period consumptionand leisure. While the optimal capital tax in the second period replicates Stiglitz (2018)’s finding, the optimal capital tax in the periods following the second period is quite different. It is determined bythe intertemporal changes of items (a) to (c) instead of the current values of (a) to (c). In particular, supposing that the taxpayers are labor averse and that there is complementarity between period con-sumption and leisure, the optimal capital tax is positive when the skill premium is rising. This is true even if the skill premium is not endogenous to capital input.

Pareto Efficient Central Redistribution with Decentralized Redistribution

In an economy with both inter- and intra-region inequality and inconsistency between the objectives of local and central governments, this paper studies optimal non-linear federal (central) income tax under non-linear regional income taxes. Starting with a benchmark model without labor mobility, it uses the variation approach to derive a statistic-based optimal federal income tax formula, which turns out to be a function of social welfare weights, regional income distributions and labor income elasticities. Unlike the traditional Mirrleesian tax, the optimal federal income tax depends on the inter-government gap of preference instead of the central government's own preference. In particular, the optimal tax rate is non-negative (non-positive) when the central government has a relatively higher (lower) preference for equality. While in an economy without labor mobility the federal income tax is limited to remedy the inconsistency of objectives, introducing labor mobility activates federal income tax's role as a Pigovian tax which internalizes the horizontal revenue externality. The numerical analysis suggests that even if the decentralized redistribution is undesirable compared to the fully centralized redistribution, it is generally desirable when combined with the central redistribution.

Redistributive Allocation Mechanisms

Many scarce public resources are allocated at below-market-clearing prices, and sometimes for free. Such mechanisms necessarily sacrifice some surplus, yet they can potentially improve equity. In this paper, we develop a model of mechanism design with redistributive concerns. Agents are characterized by a privately observed social welfare weight and willingness to pay for quality, as well as a publicly observed label. A market designer controls allocation and pricing of a set of objects of heterogeneous quality, and maximizes the expectation of a welfare function defined by the social welfare weights. We derive structural insights about the form of the optimal mechanism, leading to a framework for determining how and when to use non-market mechanisms. The key determinant is the strength of the statistical correlation of the unobserved social welfare weights with the label and the willingness to pay that the designer can, respectively, directly observe or elicit through the mechanism.

Some results from the theory of optimal taxation and their relevance for increasing the progressiveness of Indian tax structure

Results in the theoretical literature on optimal taxation are reviewed to study their relevance for the design of income and commodity tax reforms in India. Given the recent steep increase in inequality, there is a need to increase significantly the overall progressiveness of the Indian tax structure. In the absence of a comprehensive income tax base in India, where much of income escapes taxation, this can be done by greater reliance on commodity taxation. GST slabs and GST rates have to be fixed in accordance with the “many-person Ramsey rule” for commodity taxation that is based on both equity and efficiency considerations. Currently, there is not much variation in the marginal income tax rates faced by people at the high end of the income distribution, even though there is a lot of variation in their incomes. This implies that the existing income tax design gives nearly the same social welfare weights to both billionaires and salaried people with incomes close to Rs. 10,00,000. Thus, to combat the growing inequality in India, the progressiveness of income taxation at the tail of the income distribution also needs to be significantly increased, as this will be equivalent to making social preferences more inequality-averse.

Which households matter most? Capturing equity considerations in tax reform via generalised social marginal welfare weights

Social marginal welfare weights reflect the values of the social planner, or equivalently the underlying social welfare function, when evaluating the welfare impact of a change in public policy such as a tax reform. Using the nationally representative Irish Household Budget Survey, we empirically examine the sensitivity in the distribution of welfare weights to applying alternatives to the commonly employed “default” of Utilitarianism. The alternative weighting schemes we analyse are based upon: the principles of Equal Sacrifice, poverty alleviation, government self-interest and the distinction between deserving and undeserving income. We first examine the correlation between these welfare weights and the underlying measure of household resources. Then, applying these alternative welfare weights to a commonly used indirect tax reform model, the ranking of goods by distributional characteristic, the component of the model capturing distributional concerns, is shown to be highly sensitive to the choice of welfare weights. This sensitivity does not persist when demand responses are also incorporated.

Welfare effects of health insurance in Mexico: The case of Seguro Popular de Salud.

This study contributes with original empirical evidence on the distributional and welfare effects of one of the most important health policies implemented by the Mexican government in the last decade, the Seguro Popular de Salud (SPS). We analyze the effect of SPS on households’ welfare using a decomposable index that considers insured and uninsured households’ response to out-of-pocket (OOP) payments using both social welfare weights and inequality aversion. The disaggregation of the welfare index allows us to explore the heterogeneity of the SPS impact on households’ welfare. We applied propensity score matching to reduce the self-selection bias of being SPS insured. Overall results suggest non-conclusive results of the impact of SPS on households’ welfare. When we disaggregated the welfare index by different sub-population groups, our results suggest that households’ beneficiaries of SPS with older adults or living in larger cities are better protected against OOP health care payments than their uninsured counterparts. However, no effect was found among SPS-insured households living in rural and smaller cities, which is a result that could be attributed to limited access to health resources in these regions. Scaling up health insurance coverage is a necessary but not sufficient condition to ensure the protection of SPS coverage against financial risks among the poor.

Weighted Utilitarianism over Finite Streams

We provide an axiomatic analysis of weighted utilitarianism from which many available characterizations follow. We show that a social preference order over finite utility streams has a weak weighted utilitarian representation if it satisfies the axioms of Weak Pareto, Minimal Individual Symmetry, and Shift Invariance. This result can be strengthened to yield a strong (that is, complete) weighted utilitarian representation if and only if it satisfies the above three basic axioms, and an axiom on the “continuity of indifference”. Unlike many available characterizations, our result directly constructs the social welfare weights (used in the above weighted utilitarian representation results) from the preference order. Moreover, the welfare weights are uniquely identified allowing for comparative statics analysis. We show with an example that the three basic axioms do not guarantee a representation (and therefore a weighted utilitarian representation) of the preference order.

Jointly Optimal Taxes for Different Types of Income

We develop and estimate a model of jointly optimal income taxes for different types of income. Compared to standard optimal tax formulas, optimal schedular income tax rates additionally depend on cross-elasticities between tax bases capturing fiscal externalities. We discuss two applications: the taxation of different income sources such as labor or capital income and the taxation of couples. For these applications, we calculate income type-specific optimal tax rates for Germany using rich panel data from administrative tax records. We first estimate income-type specific elasticities with respect to the next-of-tax rate and show that responses to taxes differ substantially by income source and by gender. Second, we calculate social welfare weights implicit in the German personal income tax schedule which again differ between income sources and by gender. Using these estimates, we consider a tax simplification reform by calculating optimal schedular linear income tax rates. We find that optimal tax rates are significantly lower for labor income than for self-employment and capital income as well as for married women than men.

The Optimal Graduated Minimum Wage and Social Welfare

This paper analyzes the effects of introducing a graduated minimum wage in a model with optimal income taxation in which a government seeks to maximize social welfare. It shows that the optimal graduated minimum wage increases social welfare by increasing the low-productivity workers' consumption and bringing it closer to the first-best. The paper also describes how the graduated minimum wage in a social welfare optimum depends on important economy characteristics such as the government's revenue needs, the social-welfare weight of low-productivity workers, and the numbers and productivities of the different types of workers.

Political preferences for redistribution in Sweden

We examine preferences for redistribution inherent in Swedish tax policy during 1971–2012 using the inverse optimal tax approach. The income distribution is carefully characterized with the help of administrative register data, and we employ behavioral elasticities reflecting the perceived distortionary effects of taxation. The revealed social welfare weights are high for non-workers, small for low-income earners, and hump-shaped around the median. At the top, they are always negative, especially so during the high-tax years of the 1970s and ’80s. The weights on non-workers increased sharply in the 1970s, fell drastically in the late ’80s and early ’90s, and have since then increased.

Zero Optimal Marginal Tax Rates - The Norm or an Exception?

We prove in the context of optimal taxation that the utility possibility frontier can be reached with step functions. This opens a possibility of existence of legitimate - with suitably chosen marginal social welfare weights - optimal taxation problems that admit solutions of a different form than normally believed, i.e., we show that it can be the case that the optimal marginal tax rates are nearly universally equal to zero.

MITIGATION COST AND CLIMATE DAMAGE VERSUS INCENTIVE SHIFTS OF CLIMATE COALITION

Climate damage and greenhouse gas (GHG) mitigation cost plays important roles in a region’s willingness and incentives to join the global climate coalition. Negotiation of climate treaty can be modeled as a cooperative bargaining game of externality provision. The core of this game is a good representation of incentives of the participants. In this paper, we examine the relationship between the shocks of mitigation cost/climate damage and the shifts of the core of cooperative bargaining game of climate negotiation within the framework of RICE [Nordhaus and Yang, 1996. A regional dynamic general equilibrium model of alternative climate change strategies. American Economic Review, 86, 741–765], a widely used integrated assessment model (IAM) of climate change. Constructing a method that maps the core allocations onto a convex hull on the simplex of social welfare weights, we describe the scope of the core in simple metrics and capture the shifts of the core representation on the simplex in response to the shocks of mitigation cost and climate damage. A series of simulations are conducted in RICE to demonstrate the usefulness of the approach explored here. In addition, policy implications of methodological results are indicated.

Redistributive Politics and the Tyranny of the Middle Class

The Netherlands has a unique tradition in which all major Dutch political parties provide CPB Netherlands Bureau for Economic Policy Analysis with highly detailed proposals for the tax benefit system in every national election. This information allows us to quantitatively measure the redistributive preferences of political parties. For each political party we calculate social welfare weights by income level using the inverse optimal-tax method. We find that all political parties roughly give a higher social welfare weight to the poor than to the rich. Furthermore, left-wing parties attach higher social welfare weights to the poor and lower social welfare weights to the rich than right-wing parties do. However, we also discover two anomalies. First, all political parties give a much higher social welfare weight to middle incomes than to the working and non-working poor. Second, all Dutch political parties attach a slightly negative social welfare weight to the rich by setting top rates beyond the revenue-maximizing ‘Laffer’ rate. Finally, we detect a strong political status quo, since social welfare weights of all political parties hardly deviate from the welfare weights that are implied by the pre-existing tax-benefit system. We argue that political-economy considerations are key in understanding the political status quo and why middle-income groups are able to lower their tax burdens at the expense of both the low- and high-income groups.

Political Preferences for Redistribution in Sweden

We examine preferences for redistribution inherent in Swedish tax policy 1971–2012 using the inverse optimal tax approach. The income distribution is carefully characterized with the help of administrative register data and we employ behavioral elasticities reflecting the perceived distortionary effects of taxation. The revealed social welfare weights are high for non-workers, small for low-income earners, and hump-shaped around the median. At the top, they are always negative, especially so during the high-tax years of the 1970s and 80s. The weights on non-workers increased sharply in the 1970s fell drastically in the late 80s/early 90s, and have since then increased.

Good Tags, Bad Tags

In the literature on optimal taxation, a “tag” is a government-observable taxpayer attribute that is effectively immutable – like blindness, race, gender, or even height. Conventional optimal tax theory prescribes that tags should be included in the tax base so long as they are in some way correlated with “ability” or “endowment” (more precisely, with “social welfare weight”: the marginal social welfare of transferring resources to the taxpayer). Such correlation is a weak requirement. And it has recently been pointed out that the list of seemingly absurd taxes and subsidies that are thereby deemed optimal poses a challenge to the basic framework of optimal tax theory in the form of a reductio ad absurdum. This paper attempts to draw a principled distinction between two ideal types of tags – those that are directly welfare-relevant and those that are welfare-relevant only when and if they are taxed or subsidized, and only through such taxation or subsidy. A stark distinction arises between these types when the optimal tax model is extended to include the realism-enhancing feature that the government is uncertain regarding the association in the population of taxpayers between the incidence of the tag and social welfare weight. It is shown that such uncertainty generally decreases the impetus for taxation or subsidy when the attribute is non-welfare relevant, but not when it is directly welfare-relevant.