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Inequality Aversion, Externalities, and Pareto-Efficient Income taxation

Working paper
Authors Thomas Aronsson
Olof Johansson-Stenman
Publisher University of Gothenburg
Place of publication Gothenburg
Publication year 2020
Published at Department of Economics
Language en
Keywords Pareto-efficient taxation, Inequality aversion, Self-centered inequality aversion, Non-self-centered inequality aversion, Fehr and Schmidt preferences, Bolton and Ockenfels preferences, GINI coefficient, Coefficient of variation
Subject categories Economics and Business


Abstract This paper analyzes Pareto-efficient marginal income taxation taking into account externalities induced through individual inequality aversion, meaning that people have preferences for equality. In doing so, we distinguish between four different and widely used models of inequality aversion. The results show that empirically and experimentally quantified degrees of inequality aversion have potentially very strong implications for Pareto-efficient marginal income taxation. It also turns out that the type of inequality aversion (self-centered vs. non-self-centered), and the specific measures of inequality used, matter a great deal. For example, based on simulation results mimicking the disposable income distribution in the U.S., the preferences suggested by Fehr and Schmidt (1999) imply monotonically increasing marginal income taxes, with large negative marginal tax rates for low-income individuals and large positive marginal tax rates for high-income ones. In contrast, the in many respects comparable model by Bolton and Ockenfels (2000) implies close to zero marginal income tax rates for all.

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