Efficiency Criteria, Income Taxation, and Heterogeneous Elasticities

Research Question. Can income tax schedules be justified as utilitarian-optimal without adopting extreme normative assumptions about how household welfare should be measured? The paper proposes a welfare criterion strictly stronger than Pareto efficiency—called rationalizability with bounded curvature—and asks whether observed US income taxes satisfy it.

Starting Point. Any Pareto-efficient nonlinear income tax schedule can, in principle, be rationalized as utilitarian-optimal under some cardinalization of household utilities (i.e., some choice of how to measure the cardinal scale of each household’s well-being). However, the paper shows that rationalizing Pareto-efficient taxes in this way often requires cardinalizations under which there is no population upper bound on the curvature of utility with respect to consumption. Equivalently, a utilitarian planner’s marginal willingness to transfer resources to households must fall arbitrarily quickly with the size of those transfers—an extreme form of status quo bias violated by virtually all quantitative optimal-tax exercises.

André Sztutman | Macro Paper Warehouse

Efficiency Criteria, Income Taxation, and Heterogeneous Elasticities