Academic journal article Economic Inquiry

Social Preferences and Tax Policy Design: Some Experimental Evidence

Academic journal article Economic Inquiry

Social Preferences and Tax Policy Design: Some Experimental Evidence

Article excerpt


This article examines whether a taste for fairness influences people's preferences among alternative tax structures. Using an experimental approach, we devise a simple test for social preferences in voting for alternative tax structures. We find that accounting for social preferences helps explain the choices among alternative tax structures of some individuals. However, we find that the willingness to accept a smaller payoff for greater distributional equity decreases as the deadweight loss from progressive taxation increases. These findings have important implications for tax policy design. If, for example, individuals are averse to income inequality, tax structures that increase inequality may reduce individual utility. In addition, according to Alm (1998) and Andreoni, Erard, and Feinstein (1998) among others, the perceived fairness of a tax system also may influence voluntary tax compliance.

Outside the context of tax policy design, the existence of social preferences is now well established. (1) Within the context of tax policy design, the most direct evidence bearing on the fundamental issue examined in this study comes from the pathbreaking work of Engelmann and Strobel ([ES] 2004) and Frohlich and Oppenheimer ([FO] 1992). (2) FO use laboratory experiments to investigate which principle of distributive justice people choose, absent knowledge of their position in the income distribution. More specifically, they ask subjects to express a preference for a principle of distributive justice among several stylized principles, such as the maxi-min principle of Rawls (1971) and the efficiency principle of Harsanyi (1953, 1955) among others. (3) FO find that most groups choose a mixed principle: they prefer to maximize average income, as suggested by Harsanyi, constrained by an income floor for the worst-off individual as suggested by Rawls.

FO do not directly address the choice of tax structure; rather their results imply that people care about both the efficiency and distributional consequences of tax policy. Though very instructive, their experiments do not provide quantitative evidence on the nature of the trade-offs among the potentially conflicting goals of maximizing one's own payoff, maximizing the sum of individual payoffs, and maximizing the payoff of the worst-off individual. In a related study, ES use one-shot distribution experiments to compare the performance of several behavioral models, including theories reflecting social preferences. Consistent with FO, ES conclude that theories of inequality aversion have no additional explanatory power in their data beyond what can be explained by the mixed rule of efficiency and maxi-min. They also conclude that theories of inequality aversion perform poorly in cases where a distribution with less inequality is Pareto dominated by another distribution.

The focus of the current study is on the relevance of fairness motives in the choice of tax structures. We use Fehr and Schmidt's ([FS] 1999) model of inequality aversion to test whether people are willing to choose a distribution with a smaller own payoff to achieve a more equitable distribution of after-tax payoffs. In the experiments reported below, we present participants with a simple task. We randomly assign nine participants in each experimental session with a payoff that is uniformly distributed between $10 and $50, in increments of $5. Then, the participants are asked to vote for either a uniform head tax or a progressive tax. The vote of the majority determines the tax structure and consequently the distribution of after-tax payoffs to the subjects.

Thus, the laboratory experiments are designed to elicit individually held social preferences for redistributive taxation. Our central finding is that some people are willing to accept a smaller own after-tax payoff to reduce payoff inequality, but this apparent demand for fairness decreases as the cost of reducing inequality increases. …

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