Why Do We Redistribute So Much but Tag So Little? The Principle of Equal Sacrifice and Optimal Taxation

by Matthew Weinzierl

Overview — Why don't we tax personal characteristics such as height, race, and gender? The conventional optimal tax model suggests that we should, while no societies do. This paper proposes an explanation: conventional optimal tax theory has yet to capture the diversity of normative principles with which society evaluates taxes. Incorporating a role for the principle of equal sacrifice in how taxes are designed, a principle held by many leading thinkers to be the natural criterion of justice in taxation, substantially improves the match between the theory of optimal taxes and the reality of tax policy. This alternative reconciles three features of real-world policy that seemed incompatible in the standard model: limited taxation of personal characteristics not directly linked to ability, moderate marginal tax rates at high incomes, and substantial redistribution to the poor. Key concepts include:

Incorporating the principle of equal sacrifice, a principle held by many leading thinkers to be the natural criterion of justice in taxation, substantially improves the match between the theory of optimal taxes and the reality of tax policy.
This alternative reconciles three features of real-world policy that seemed incompatible in the standard model: limited tagging of personal characteristics not directly linked to ability, moderate marginal tax rates at high incomes, and substantial redistribution to the poor.
The tradeoff between equality and efficiency is not the only one that matters for tax policy. Instead, society also faces a tradeoff between a diversity of normative frameworks, each of which carries some weight in the evaluation of policy.

Author Abstract

Tagging is a free lunch in conventional optimal tax theory because it eases the classic tradeoff between efficiency and equality. But tagging is used in only limited ways in tax policy. I propose one explanation: conventional optimal tax theory has yet to capture the diversity of normative principles with which society evaluates taxes. I generalize the conventional model to incorporate multiple normative frameworks. I then show that if the principle of equal sacrifice-a classic, comprehensive criterion of fair taxation proposed by John Stuart Mill and associated with the Libertarian normative framework-is given some weight in the social objective function, tagging generates costs that must be weighed against the benefits it generates through conventional channels. Only tags that are sufficiently predictive of ability, such as disability status, will be used. Calibrated simulations using micro data from the United States show that optimal policy may simultaneously include substantial redistribution across income-earning abilities, as in the standard model, and reject three prominently-proposed tags-gender, race, and height-as in actual policy. This explanation for limited tagging also implies that optimal marginal tax rates at high incomes are lower than in standard analysis and closer to those observed in policy.