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Optimal Redistribution: Rising Inequality vs. Rising Living Standards

Author

Listed:
  • Axelle Ferriere

    (CNRS - Centre National de la Recherche Scientifique, ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique)

  • Philipp Grübener

    (WUSTL - Washington University in Saint Louis)

  • Dominik Sachs

    (HSG - University of St.Gallen)

Abstract

Over the last decades, the United States has experienced a large increase in, both, income inequality and living standards. The workhorse models of optimal income taxation call for more redistribution as inequality rises. By contrast, living standards play no role for taxes and transfers in these homothetic environments. This paper incorporates living standards into the optimal income tax problem by means of non-homothetic preferences. In a Mirrlees setup, we show that rising living standards alter both sides of the equity-efficiency trade-off. As an economy becomes richer, non-homotheticities imply a fall in the dispersion of marginal utilities, which weakens distributional concerns but has ambiguous effects on efficiency concerns. In a dynamic incomplete-market setup calibrated to the United States in 1950 and 2010, we quantify this new channel. Rising living standards dampen by around 30% the desired increase in redistribution due to rising inequality.

Suggested Citation

  • Axelle Ferriere & Philipp Grübener & Dominik Sachs, 2025. "Optimal Redistribution: Rising Inequality vs. Rising Living Standards," SciencePo Working papers Main hal-04849262, HAL.
    • Handle: RePEc:hal:spmain:hal-04849262
    Note: View the original document on HAL open archive server: https://sciencespo.hal.science/hal-04849262v2
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