Positional Externalities as an Argument for Tax Progressivity: A Critical Analysis

Anthony J. Quain

Advisor: Daniel B Klein, PhD, Department of Economics

Committee Members: Bryan Caplan, Garett Jones

Carow Hall, #11
November 15, 2013, 01:30 PM to 11:00 AM


In the last forty years, social science research has demonstrated that individuals care significantly about relative (“positional”) economic well-being and that gains in private income and/or consumption thereby casts a negative externality on other individuals whose own income and/or consumption declines in relative terms. To resolve the externality, a progressive income or consumption tax has been advocated. In this dissertation I present three papers that critically analyze tax progressivity as a response to positional externalities.

In “Income Variation and Tax Progressivity,” I develop two empirical models to determine how progressive taxation penalizes taxpayers with varying (“lumpy”) income and how income varies over the average individual’s life cycle. I conclude that progressivity results in significant differences in tax burden between people with differently patterned but otherwise equal income, and such differences in burdens may have important implications for the efficiency and equity of progressive tax policy.

In the second paper, “Adaptation, Growth, and Tax Progressivity,” I attempt to measure the welfare effects of progressivity given the well-known effects of adaptation. I construct a theoretical utility model using the life-cycle income model developed in the first paper and combining the utility effects of absolute consumption, positional consumption, consumption growth, and leisure. I postulate that utility from consumption growth, a result of adaptation, is negatively affected by tax progressivity at every level of income. I conclude that the overall effect on utility balances the negative effect with the expected positive effects of increased leisure but depends critically on the relative weight of utility components and other exogenous variables.

In the third paper, “Alternatives to Taxing Positional Externalities,” I discuss ways in which individuals and institutions, especially in the private realm, can act to mitigate the problems associated with positionality. I examine the possibility of diminishing positional externalities through direct behavioral modification as an alternative to Pigovian taxation. Four non-tax approaches are suggested: reducing envy and upward positional comparisons; reducing vanity and the exhibitions of positional superiority; tailoring reference groups to reduce the salience and occurrence of positional comparisons; and excluding the reference group to referents exogenous to social welfare. Building on the conclusions of the second paper, I also summarize the specific problems of tax progressivity in reducing positional comparisons and addressing positional externalities.