One Dynamic Game for Two Veblenian Ideas. Income Redistribution is Pareto-Improving in the Presence of Social Concerns

In a status game, homogenous individuals first decide on their income (and on the effort necessary to that end) with the aim of Getting ahead of the Smiths (GAS). Next, they make use of a pure positional good to make incomes visible. Although the GAS hypothesis is ordinal, the signaling costs induce cardinal social concerns. The GAS hypothesis, translated into the pure pride concern, generates an equilibrium in which identical agents have unequal income levels. Because individuals decide on their income without taking into account its effect on the signaling costs of higher-ranked participants, this equilibrium is inefficient. Introducing a Pigovian tax to reduce conspicuous consumption generates a rat-race effect in the income-setting stage which neutralizes the effect of this tax on utilities. But a redistributive income tax, if coupled with an appropriate Pigovian tax on conspicuous consumption, increases all utilities.