Working Paper: NBER ID: w14170
Authors: Louis Kaplow
Abstract: Optimal policy rules--including those regarding income taxation, commodity taxation, public goods, and externalities--are typically derived in models with homogeneous preferences. This article reconsiders many central results for the case in which preferences for commodities, public goods, and externalities are heterogeneous. When preference differences are observable, standard second-best results in basic settings are unaffected, except those for the optimal income tax. Optimal levels of income taxation may be higher, the same, or lower on types who derive more utility from various goods, depending on the nature of preference differences and the concavity of the social welfare function. When preference differences are unobservable, all policy rules may change. The determinants of even the direction of optimal rule adjustments are many and subtle.
Keywords: optimal policy; heterogeneous preferences; income taxation; commodity taxation; public goods; externalities
JEL Codes: D61; D62; D63; H21; H23; H24; H43; K34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| observable preference differences (J79) | optimal income taxation (H21) |
| unobservable preference differences (D11) | uniform commodity taxation undesirable (H29) |
| observable preferences (C91) | optimal provision of public goods and regulation of externalities (H49) |
| unobservable preferences (D11) | deviations from Samuelson rule and Pigouvian principles (D62) |