Optimal Taxation When the Tax Burden Matters

Abstract

Survey evidence shows that the magnitude of the tax liability plays a role in value judgements about which groups deserve tax breaks. Such considerations can be explained with a role for the tax burden itself, but do not follow from standard welfarist optimal taxation. We show that the German tax-transfer system is not in line with a standard welfarist inequality averse social planner. Instead, it is optimal according to a planner who is both inequality averse and wants to avoid high tax liabilities. Such a tax-transfer schedule reflects non-welfarist value judgements of citizens in line with survey evidence or might arise if there is misspecification on the side of policy makers. Additionally, we show that redistributive systems are inconsistent with an inequality averse welfarist social planner in 17 European countries and the USA. The redistributive systems in 50% of these countries can be rationalized with an inequality averse social planner for whom the absolute tax burden matters.