CONTENTS 2. Human Capital 3. Charitable givi 20 11. Taxation and social securit y A. Redistribution 1. Labor Income Tax Comparison 2. Lifetime Income 278 3. Intergenerational Redistribution 4. Redistribution across Family Types B. Forced savings 291 ply 295 b. Nonmyopic labor supply 30 5. Relationship to Redistribution 310 312 12. Taxation of Families 315 317 Unequal Sharin 320 2. Economies of scale 323 3. Intrafamily Transfer Motives 325 b. Utility from sharing per se 327 Exchange 329 4. Children 5. Distributive Shares as a Function of income 1. Labor effort 333 a. One-worker families b. Two-worker families 341 b. Procrea 1_Kaplow_Prelims_pooi-pxxii indd
contents xiii 2. Human Capital 269 3. Charitable Giving 270 11. Taxation and Social Security 275 A. Redistribution 276 1. Labor Income Tax Comparison 276 2. Lifetime Income 278 3. Intergenerational Redistribution 285 4. Redistribution across Family Types 289 B. Forced Savings 290 1. Myopia 291 a. Myopic labor supply 295 b. Nonmyopic labor supply 298 2. Samaritan’s Dilemma 301 3. Liquidity Constraints 306 4. Heterogeneity 309 5. Relationship to Redistribution 310 C. Insurance 312 12. Taxation of Families 315 A. Distribution 317 1. Unequal Sharing 320 2. Economies of Scale 323 3. Intrafamily Transfer Motives 325 a. Altruism 326 b. Utility from sharing per se 327 c. Exchange 329 4. Children 329 5. Distributive Shares as a Function of Income 332 B. Incentives 333 1. Labor Effort 333 a. One-worker families 333 b. Two-worker families 337 2. Endogenous Family Structure 341 a. Marriage 341 b. Procreation 343 01_Kaplow_Prelims_p00i-pxxii.indd xiii 1_Kaplow_Prelims_p00i-pxxii.indd xiii 10/16/2007 11:21:00 AM 0/16/2007 11:21:00 AM
XIV CONTENTS PART V: DISTRIBUTIVE JUSTICE AND SOCIAL WELFARE 13. Welfare A. Welfarism 1. Definition 2. Basis for Welfarism 3. Perspectives on Welfarism 351 b. Moral intuitions C. Relevance of nonwelfarist principles under 1. Definitio 2. Limited Information and Other Decision-Making Infirmities 360 3. Other-Regarding Preferences 362 4. Capabilities, Primary Goods, and Well-Being 367 14. Social Welfare function Aggregatio 370 1. Frameworks 370 370 b. Social rationalist 375 b. Weight on equality B. Membership in Society 378 3. Population Size 387 15. Other Normative Criteria 391 A. Inequality, Poverty, Progressivity, Redistribution 392 B. Horizontal Equity 1_Kaplow_Prelims_pooi-pxxii indd xi
xiv contents PART V: DISTRIBUTIVE JUSTICE AND SOCIAL WELFARE 13. Welfare 347 A. Welfarism 348 1. Defi nition 348 2. Basis for Welfarism 349 3. Perspectives on Welfarism 351 a. Two-level moral theory 352 b. Moral intuitions 354 c. Relevance of nonwelfarist principles under welfarism 357 B. Well-Being 359 1. Defi nition 359 2. Limited Information and Other Decision-Making Infi rmities 360 3. Other-Regarding Preferences 362 4. Capabilities, Primary Goods, and Well-Being 367 14. Social Welfare Function 370 A. Aggregation 370 1. Frameworks 370 a. Original position 370 b. Social rationality 373 2. Concerns 375 a. Interpersonal comparisons of utility 375 b. Weight on equality 377 B. Membership in Society 378 1. National Boundaries 378 2. Future Generations 382 3. Population Size 387 15. Other Normative Criteria 391 A. Inequality, Poverty, Progressivity, Redistribution 392 B. Horizontal Equity 396 C. Sacrifi ce Theories 401 01_Kaplow_Prelims_p00i-pxxii.indd xiv 1_Kaplow_Prelims_p00i-pxxii.indd xiv 10/16/2007 11:21:00 AM 0/16/2007 11:21:00 AM
CONTENTS D. Benefit Principle 403 E. Ability to Pay 404 E. Definitions as norms 16. Conclusion 407 erences 417 Index 455 01__Prelims_pooi-PxxiLinddxv
contents xv D. Benefi t Principle 403 E. Ability to Pay 404 F. Defi nitions as Norms 405 16. Conclusion 407 References 417 Index 455 01_Kaplow_Prelims_p00i-pxxii.indd xv 1_Kaplow_Prelims_p00i-pxxii.indd xv 10/16/2007 11:21:00 AM 0/16/2007 11:21:00 AM
Presa The purpose of this book is to offer a unifying conceptual framework for the normative study of taxation and related subjects in public eco- nomics. Such a framework necessarily begins with a statement of the social objective, taken here to be the maximization of a conventional social welfare function, and then asks how various government instru ments are best orchestrated to achieve it. the structure is built on the foundation provided by the fundamental theorems of welfare econom- ics. The key deviation is due to the infeasibility of redistribution by in dividualized lump-sum taxation. Because of this limitation, the fiscal system relies significantly on income taxation, which gives rise to the basic tradeoff between distribution and distortion fy motivating premise is that the analysis of various forms of taxa- tion and of many other topics must be grounded explicitly in this frame work. As a matter of a priori theory, this assertion seems self-evident. Its importance is reinforced by two considerations. First, the optimal use any one instrument depends on which others are available and how they are employed. In the present context, the pivotal role of the income tax is particularly significant, and analysis that focuses on other instruments in isolation may be problematic. Second, in complex, second-best set tings, failure to examine all the effects of a policy in terms of social wel fare can be dangerous. For example, a reform that is found to reduce labor supply distortion may seem desirable on that account, but the re- form may concomitantly reduce redistribution, perhaps to such an ex tent that overall welfare is lower. Examining only one set of effects can be misleading, especially when the omitted effects may systematically run in the opposite direction. The most direct way to meet the challenge would be to optimize all instruments simultaneously. This task, however, is quite daunting even with only a few instruments and minimal complicating assumptions- all the more so when one piece of the problem includes optimal deploy- ment of a nonlinear income tax. an alternative strategy, developed and 01_Kaplow_Prelims_pooi-pxoxii indd xv
Preface a The purpose of this book is to offer a unifying conceptual framework for the normative study of taxation and related subjects in public economics. Such a framework necessarily begins with a statement of the social objective, taken here to be the maximization of a conventional social welfare function, and then asks how various government instruments are best orchestrated to achieve it. The structure is built on the foundation provided by the fundamental theorems of welfare economics. The key deviation is due to the infeasibility of redistribution by individualized lump-sum taxation. Because of this limitation, the fi scal system relies signifi cantly on income taxation, which gives rise to the basic tradeoff between distribution and distortion. My motivating premise is that the analysis of various forms of taxation and of many other topics must be grounded explicitly in this framework. As a matter of a priori theory, this assertion seems self-evident. Its importance is reinforced by two considerations. First, the optimal use of any one instrument depends on which others are available and how they are employed. In the present context, the pivotal role of the income tax is particularly signifi cant, and analysis that focuses on other instruments in isolation may be problematic. Second, in complex, second-best settings, failure to examine all the effects of a policy in terms of social welfare can be dangerous. For example, a reform that is found to reduce labor supply distortion may seem desirable on that account, but the reform may concomitantly reduce redistribution, perhaps to such an extent that overall welfare is lower. Examining only one set of effects can be misleading, especially when the omitted effects may systematically run in the opposite direction. The most direct way to meet the challenge would be to optimize all instruments simultaneously. This task, however, is quite daunting even with only a few instruments and minimal complicating assumptions— all the more so when one piece of the problem includes optimal deployment of a nonlinear income tax. An alternative strategy, developed and 01_Kaplow_Prelims_p00i-pxxii.indd xvii 1_Kaplow_Prelims_p00i-pxxii.indd xvii 10/16/2007 11:21:00 AM 0/16/2007 11:21:00 AM
REFACE frequently applied in this book, is to use a construction that makes ossible to(legitimately)set aside much complexity and examine a few elements at a time. Specifically, in order to analyze a given policy-such as a modification to commodity taxes, transfer(estate and gift)taxation, public goods provision, or some means of regulating externalities-the policy is combined with a distributively offsetting adjustment to the in come tax. The net result is a reform package that is distribution neutral, which, as will be seen, holds much constant and leaves in play the dis tinctive effects of the policy instrument under consideration, ones that can then more readily be evaluated. In most areas of economics, it is standard practice to relate analysis to a paradigmatic setting, often one closely related to the simplified world of the two welfare theorems. This methodology enhances rigor, econo- mizes on effort, generates benefits from cross-fertilization, and facilitates understanding and communication For taxation and many other public economics questions, the same advantages can be realized by adopting such an approach, although, as noted, the benchmark scenario should be the second-best one in which an income tax is present and redistri bution is accomplished imperfectly and at a cost. My goal is to pursue this line of inquiry systematically in order to enhance our understand ing of the theory of taxation and of public economics more broadly. The ambition of this project is similar in spirit to that of Musgrave in The Theory of Public Finance and of some of his predecessors, including Pigou and Vickrey. The closest modern incarnation is Atkinson and Stiglitz's Lectures on Public Economics, which builds importantly on Mirrlees's seminal paper on optimal nonlinear income taxation. There has been a tremendous growth in research since these works, which is reflected in texts and surveys such as those in the four volumes of the Handbook of Public Economics This book is meant to be complementary to these more recent efforts Most of them are rather specialized, presenting often-subtle develop ments on particular topics but attending less to interactions among the various pieces. It is inevitable and appropriate that most research and even most syntheses of research will be of this nature. Nevertheless, it useful from time to time to step back and reflect carefully and precisely on the whole enterprise and to trace directly the relationships among each of its constituent parts Such an exercise ought to produce payoffs 01_Kaplow_Prelims_pooi-pxoxii indd
xviii preface frequently applied in this book, is to use a construction that makes it possible to (legitimately) set aside much complexity and examine a few elements at a time. Specifi cally, in order to analyze a given policy—such as a modifi cation to commodity taxes, transfer (estate and gift) taxation, public goods provision, or some means of regulating externalities—the policy is combined with a distributively offsetting adjustment to the income tax. The net result is a reform package that is distribution neutral, which, as will be seen, holds much constant and leaves in play the distinctive effects of the policy instrument under consideration, ones that can then more readily be evaluated. In most areas of economics, it is standard practice to relate analysis to a paradigmatic setting, often one closely related to the simplifi ed world of the two welfare theorems. This methodology enhances rigor, economizes on effort, generates benefi ts from cross-fertilization, and facilitates understanding and communication. For taxation and many other public economics questions, the same advantages can be realized by adopting such an approach, although, as noted, the benchmark scenario should be the second-best one in which an income tax is present and redistribution is accomplished imperfectly and at a cost. My goal is to pursue this line of inquiry systematically in order to enhance our understanding of the theory of taxation and of public economics more broadly. The ambition of this project is similar in spirit to that of Musgrave in The Theory of Public Finance and of some of his predecessors, including Pigou and Vickrey. The closest modern incarnation is Atkinson and Stiglitz’s Lectures on Public Economics, which builds importantly on Mirrlees’s seminal paper on optimal nonlinear income taxation. There has been a tremendous growth in research since these works, which is refl ected in texts and surveys such as those in the four volumes of the Handbook of Public Economics. This book is meant to be complementary to these more recent efforts. Most of them are rather specialized, presenting often-subtle developments on particular topics but attending less to interactions among the various pieces. It is inevitable and appropriate that most research and even most syntheses of research will be of this nature. Nevertheless, it is useful from time to time to step back and refl ect carefully and precisely on the whole enterprise and to trace directly the relationships among each of its constituent parts. Such an exercise ought to produce payoffs 01_Kaplow_Prelims_p00i-pxxii.indd xviii 1_Kaplow_Prelims_p00i-pxxii.indd xviii 10/16/2007 11:21:00 AM 0/16/2007 11:21:00 AM