Optimal Taxation and Political Equilibrium with Fairness Consideration

Abstract

In this paper, I investigate the optimal taxation of labor and capital as well as the political equilibrium when people are homogeneous and have a preference for fairness. Not surprisingly, the optimal taxation takes a variant Ramsey-Mirrlees formula. I then fully characterize the equilibrium fiscal policy and find conditions under which the maximum capital levy holds. In particular, I show that an additional concern for fairness may enforce or weaken the maximum capital levy result in an intuitive manner. For example, if the degree to which labor income is determined by stochastic shocks with respect to talent and effort is relatively larger than that of capital income, the maximum capital levy and hence no tax on labor is less plausible to obtain on equilibrium. Copyright © 2007 The Author; Journal compilation © 2007 Blackwell Publishing Ltd and The University of Manchester.