Abstract:
The vast majority of economic models assume that individuals are indifferent to the level of inequality within their society. If inequality affects individual or societal outcomes - such as mental health, political efficiency, or crime rates, for instance - this assumption may lead to misleading theoretical outcomes. This paper proposes to treat inequality as an economic externality in order to remedy these issues. Doing so allows us to introduce the societal effects of income inequality into welfarist models, and novel policy implications are illustrated through the classic non-linear optimal income taxation model. In this model we find that (i) optimal marginal top tax rates depend robustly and strongly on the magnitude of the inequality externality, ranging between 37% and 92% with only moderate externality magnitudes, (ii) resulting optimal income tax rates become unambiguously more progressive with a negative inequality externality (and vice versa), (iii) optimal rates above the revenue-maximizing Laffer rate are observed. Overall, our findings indicate that the magnitude of the inequality externality can have far-reaching implications on optimal policy design.
Please note:
Due to Covid-19 restrictions the maximum capacity in room 1047 is 20 people. The seminar will also be broadcast on Zoom.