Is fighting inequality costly? Not when homo socialis is added to homo economicus

The advanced economies have been plagued by rising inequality during recent decades. This trend is widely accepted as socially and politically dangerous; the present US election campaign shows that owners of extreme wealth may seem to be able almost to buy the presidency; other such examples abound. Yet it is also believed that tinkering with market determined distribution, e.g., by the imposition of high marginal taxes, saps incentives and leads to the withdrawal of productive effort. This paper claims that this assumption is unfounded, because human tastes, as usually viewed in economics, often disregard our social needs. We have to take account of homo socialis, man or woman as a social animal in the utility function and recognize the need, for the great majority of us, for social standing and rank. What counts for social status is not the absolute value of the resources that we command, or other badges of success, but where we stand relative to others in our reference group. Any change that does not affect our rank within our social environment will therefore not impinge on effort.

Regarding tastes, the paper assumes that below subsistence incomes absolute resources are all-important, but once incomes rise, the weight of social standing and relative income rises. Consequently, at very high incomes proportional taxes should not distort incentives. There exists historical evidence that such taxes need not affect incentives: confiscatory marginal taxes on the very highest incomes coincided in the aftermath of World War II with the fastest growth rates.

On the other hand, this may seem to run counter to the finding of the celebrated Organization for Economic Cooperation and Development (OECD) study of the effect of taxation on growth,[1]that finds that high marginal taxes harm growth. Yet a closer reading of the OECD paper shows that it defines marginal taxes as taxes on mean incomes, not on extremely high ones, and is therefore not relevant to the subject at hand.

After discussing the hypothesis described above, the paper introduces a model and the rank determining game. It also presents some evidence in support of the hypothesis, some of which is mentioned above.

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1. Arnold, Jens, (2015). “Do Tax Structures Affect Aggregate Economic Growth? Empirical Evidence from a Panel of OECD Countries”.  OECD Economics Department Working Papers No. 643.