Consistent income tax structures when households are heterogeneous (Q1976443): Difference between revisions

One can invoke many purposes to justify a system of taxation, one of the more obvious one being the need to finance the government. In the theory of Social Choice, the point of view adopted in this paper, this purpose is the reduction of income inequality. In this optic, it is important that the income distribution is more equitable after tax than before: there is no point to rob (rich) Peter to give to (poor) Paul just to end up with a rich Paul and a poor Peter. The challenge is to design a tax system that would always reduce inequality, whether it is applied to a country with wide initial disparities, or to a country with many disparate groups with varying circumstances, or to a country in which households of various sizes (singles, couples, large families, \dots) live side by side. Of course, the system cannot be nominal; the taxation method must rely on a few observable characteristics of the tax payer (income, size of the household, \dots). When dealing with homogeneous populations, the design of a progressive tax system (i.e. which will reduce income inequality) relies on the intuitive notion that the tax rate should be one with income. With non homogeneous populations that differ with respect to household size, number and age of children, state of health, i.e. differ with respect to their needs, the reducing income inequality becomes a much greater undertaking. In practice, the tax authorities start by adjusting income to the tax payer circumstances, in the paper referred `equivalent income function', then subject this adjusted income to a nondecreasing tax rate. This paper shows that, in the presence of imperfect information, it is not possible to construct this equivalent income function independently of the tax schedule (as is the case in practice) and still guarantee the progressiveness, in a broad sense, of the tax system for all possible distributions of income/household characteristics. However, different equivalent income functions are consistent with narrow definitions of progressiveness and, hence, reveal the inequality concept that underlies the actions of a (perfectly consistent) tax authority.