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The peer group effect and the optimality properties of head and income taxes

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  • Francisco Martinez Mora

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Abstract

This paper studies a Tiebout model with two school districts, housing markets and peer effects to re-evaluate the optimality properties of the allocation of households to districts induced by head and income taxes. The main novel results reveal that head taxes are not superior to income taxes and that the indirect redistribution implied by income taxation is not necessarily at odds with location optimality or associated to welfare losses. Many combinations of head taxes differentiated by household type can sustain the optimal outcome as an equilibrium. While this may not be possible using differentiated income taxes, a combination of non-differentiated ones and differentiated head taxes levied on the residents of the rich district can lead to the optimal outcome and effect significant local redistribution. In turn, non-differentiated head taxes are suboptimal (unless optimality requires one of the districts to be type-homogeneous) and a combination of uniform income taxes and head taxes levied on the rich district's population can do as well as them. Moreover, non-differentiated income taxes may generate smaller welfare losses than their lump-sum counterpart, a result which clashes with the benefit view of head taxes.

Suggested Citation

  • Francisco Martinez Mora, 2011. "The peer group effect and the optimality properties of head and income taxes," Discussion Papers in Economics 11/26, Department of Economics, University of Leicester.
  • Handle: RePEc:lec:leecon:11/26
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    References listed on IDEAS

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    1. de Bartolome, Charles A. M. & Ross, Stephen L., 2004. "Who's in charge of the central city? The conflict between efficiency and equity in the design of a metropolitan area," Journal of Urban Economics, Elsevier, vol. 56(3), pages 458-483, November.
    2. de Bartolome, Charles A M, 1990. "Equilibrium and Inefficiency in a Community Model with Peer Group Effects," Journal of Political Economy, University of Chicago Press, vol. 98(1), pages 110-133, February.
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    Keywords

    Tiebout; peer effects; head tax; income tax; optimality;

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