Nontaxable income and necessary consumption: the Rousseau’s paradox of fiscal egalitarianism

Abstract

This article compares a tax method featuring flat rates and fixed allowances equal for all taxpayers (Surplus Income Tax Method (SITM) procedure) with a tax method featuring also flat rates and increasing personal allowances (IPAs) to meet the amounts of necessary consumption required by the different living standards (Discretionary Income Tax Method (DITM) procedure). Our results show that the DITM procedure generates an after-tax income distribution less unequal and superior in terms of social welfare. Moreover, the assumption (for comparison purposes) of identical total tax revenues leads to the corollary that the flat tax rate under the DITM is necessarily larger than the one under the SITM; being thus, the former taxmethod is more progressive than the latter. These results imply an obvious paradox considering the commonly accepted principle that basic necessities are the same for everyone (Rousseau, 1755). Based on the results obtained in this article, we have labelled this paradox as the Rousseau’s paradox of fiscal egalitarianism.

Keywords:

• personal allowances
• necessary consumption
• progressivity
• social welfare

JEL Classification:

• D31
• D63
• H24

Acknowledgements

The authors thank the editors of this special issue, Josep Lluis Carrion and Emma Iglesias, and also the anonymous referees whose comments and suggestions have helped to improve the quality of the article. A substantial part of this paper has been finished while the second and the third authors were visiting scholars at the Economics Departments at Suffolk and Harvard University, respectively. The second author thanks professors Pol Antràs and Nathan Nunn for sponsoring his visiting position at Harvard University. The third author thanks professors Sebastián Royo, David Tuerck and Rafael Myro for sponsoring her visiting position at Suffolk. All these colleagues gave us very good comments and discussions while drafting this article. We have benefited from useful remarks from audiences at various seminars and conferences, and we are particularly indebted to Geoffrey Hewings, David Tuerck and Sandy D’ allerba for their useful conversations and suggestions during the visits of the second and third authors to the University of Arizona,Suffolk University and the Regional Economics Application Laboratory (REAL) at the University of Illinois at Urbana Champaign. We also thank Fidel Picos for his help on the empirical part of this article.

The authors thank the Institute for Fiscal Studies (IEF) for providing the data used in this article. Financial support from the Spanish Ministry of Science and Innovation through Grant ECO2011-28632 is gratefully acknowledged. The usual disclaimer applies. The opinions, analyses and results of this work are the exclusive responsibility of the authors and do not represent the position of the European Commission.

Notes

1 Necessary consumption is a concept that involves a sort of flexibility in three aspects: time, space and type of household. Different households have different levels of necessary consumption according to their different levels of income and size.; the kind of goods and services which were not considered necessary in the past, for instance, ITC services, became nowadays necessary; necessary goods and services also vary according to the different geographical settings considered.

2 For a detailed analysis of the microeconomic tools and econometric techniques that allow the estimation of necessary consumption, see Deaton and Mullbauer (1980). More recently, an applied analysis to the Pakistan case can be seen in Schamim and Ahmad (2006).

3 x_i represents the expenditure on the good i in monetary terms.

4 This assumption does not imply any loss of generality, since no tax liabilities are generated under the threshold a.

5 See Equation 3.

6 s’_NC(y) is a decreasing function of personal income, y, and its values lay in the interval [1,0] for personal incomes in the interval [a,m].

7 In the interval [a, y*], necessary consumption takes a high share of personal income. Note that the share of necessary consumption overpersonal income, S_NC(y), is a decreasing function of personal income varying monotonously between and .

8 The income threshold (y*) for which both tax methods generate the same tax liabilities is given by the following condition: so that .

9 is characterized by the condition .

10 Data on these computations can be made available on request.

11 In Rousseau’s words, ‘grandees’ necessary consumption remains practically constant as income increases, and this is the reason why they are punished under this alternative procedure.