Social Preferences Revealed through Effective Marginal Tax Rates

Abstract

This paper inverts the usual logic of the applied optimal income taxation literature. Standard practice analyzes the shape of the optimal tax schedule that is consistent with a given social welfare function, a statistical distribution of individual productivities that fits available data on labor incomes and given preferences between consumption and leisure. In this paper, we go the opposite direction. We start from the observed distribution of gross and disposable income within a population and from the observed marginal tax rates as computed in standard tax-benefit models. We then show that, under a set of simplifying assumptions, it is possible to identify the social welfare function that would make the observed marginal tax rate schedule optimal under some assumption about consumption-leisure preferences. This provides an alternative way of reading marginal tax rates calculations routinely provided by tax-benefit models. In that framework, the issue of the optimality of an existing tax-benefit system may be analyzed by considering whether the social welfare function associated with that system satisfies elementary properties. Likewise, the reform of an existing system may be seen as a change in the underlying social welfare function which may prove to be less consensual than the reform itself. A detailed application is given in the case of France, and of a basic income/flat tax reform of the tax-benefit system in that country. For comparability, an application is also made to several other EU countries.