Redistribution through the Income Tax

Abstract

Empirical analysis reveals that, typically, the impact effect of the personal income tax is unambiguously to reduce inequality in the distribution of income. This would be explained by theory if all incomes were taxed according to the same progressive schedule. However, tax treatment typically depends on equity-relevant non-income attributes, so that the normative significance of inequality reduction is unclear. In this paper, the income tax is viewed as equivalent to the imposition of a proportional (distributionally neutral) tax followed by ‘Robin Hood activity’. A class of welfare functions is proposed in terms of which Robin Hood’s interference in distribution could be justified, and it is found that inequality reduction is a necessary condition. Whether real-world income taxes are in fact welfare superior to equal-yield proportional taxes according to the criterion proposed is an open question, but the observed inequality reduction, and certain other evidence, is in favour.

This paper is adapted from an article of the same title appearing as chapter 1 in Creedy (1993). I thank John Creedy for permission to use the material here, and for helpful comments.