Why 70% Makes No Sense
A response to Brad DeLong on the top marginal tax rate
What are "heterogenous preferences"? In the Lockwood-Weinzierl model, it means that, in short, people placing different relative marginal values on increases in income versus increases in leisure.
They matter because in a conventional Mirrleesian model, which assumes total homogenous preferences, the only explanations for differences in income are luck and differences of ability. This explains the Diamond-Saez finding, as Lockwood and Weinzierl argued, that the United States' marginal income tax rate structure is insufficiently progressive and redistributive to maximize social welfare.
Enter preference heterogeneity, and the differences in income can be explained by differences in preferences as well as luck and differences of ability (i.e. the three factors can receive different weights as explanatory variables). Obviously, preference heterogeneity means that the utility calculations aren't as simple as before, but because we know now that the distribution is by some measure closer to optimal then a random question of luck and ability, the economic case for redistribution is meaningfully weakened.
There is so much more in this fascinating study, too. A gem.The results from theory are clear: taking preferences into account lowers optimal redistribution for themost plausible specifcations of the model. We start by showing that, if preferences and ability are the same for all individuals with a given income (as in the standard model), attributing more of the variationin incomes across individuals to preferences rather than ability lowers the optimal linear tax rate. Then, we show that if preferences and ability vary conditional on income, preference heterogeneity is even more likely to reduce optimal redistribution relative to standard results.