Redistributive Taxation with Heterogenous Relative Consumption Concerns

This paper examines linear income taxation in a model where preferences over relative consumption are only exhibited by some individuals in the population. This heterogeneity in preferences generates several interesting issues in the optimal tax context. We analyze cases where the tax authority (1) uses a non-welfarist objective (one which places variable weight on the welfare of relatively-concerned agents), or (2) remains ignorant of preference heterogeneity and maintains a standard social welfare function. Numerical results are obtained to illustrate ‘optimal’ tax parameters. A key result is that a government which understands the extent of relative consumption concerns — but places no social weight on individuals with such preferences — nevertheless sets a significantly more progressive tax system than a government ignorant of relative-consumption motivations. ∗AUTHOR: Assistant Professor, Department of Economics, Carleton University, 1125 Colonel By Drive, Ottawa, Ontario, Canada, K1S 5B6. email: [email protected]. PRELIMINARY: Please do not quote or cite without permission. Comments welcome. All errors are my own.