This paper compares the use of equivalent income with that of utility, in the social welfare function, in optimal income tax models. Equivalent income is a money metric welfare measure that, unlike utility, is not affected by monotonic transformations of utility. The use of equivalent income is found to produce an optimal tax rate that is more sensitive to the degree of inequality aversion, compared with the use of utility. With Cobb‐Douglas and CES utility functions, the optimal tax rate is the same for utility and equivalent income where relative inequality aversion is unity. When using equivalent incomes, the case for high marginal rates does not depend on the assumption of a very low elasticity of substitution between consumption and leisure.
This paper illustrates the use of different criteria used to evaluate alternative tax and transfer systems. Means‐tested and universal transfer systems are compared, using numerical examples involving a small number of individuals, in order to highlight the precise effects on incomes. The implications of fixed incomes and of endogenous incomes, using constant elasticity of substitution utility functions, are examined. Comparisons between tax systems involve fundamental value judgements concerning inequality and poverty, and no tax structure can be regarded as unambiguously superior to another. Judgements depend on the degree of inequality aversion and attitudes to poverty. However, in cases where means‐testing is preferred, the desired tax or taper rate applying to benefits is substantially less than 100 per cent.
This paper provides an introduction to some aspects of the role of taxes in a static general equilibrium framework. The standard diagrammatic framework is first used, in the case of fixed factor supplies, in order to examine selective commodity and factor taxes. A simple two‐sector model, with Cobb–Douglas production functions and preferences, and allowing labour supplies to be endogenous, is then constructed. Several tax policies are examined using numerical examples.
Abstract This article discusses some of the issues involved in making comparisons of income distributions using cross‐sectional data and in examining the dynamics of income distribution using longitudinal data. Any study of income distribution must consider the unit of analysis, the time period and the measure of income, and these are the focus of the article. Section 2, on annual incomes, begins with problems of intra‐household income sharing and the measure of income used, including household production. Comparisons among households of different size are discussed, involving the choice of equivalence scales, the use of decomposition analysis and more general dominance conditions. The role of value judgments in the use of equivalence scales is stressed. Section 3 is concerned with dynamic aspects of income distribution. It discusses methods of constructing synthetic cohorts for use in simulation exercises, the varieties of longitudinal data available, sample attrition and the unit of analysis. An appendix provides further references to the literature and data sources.