Evan Soltas
Jan 2, 2013

A Public Finance Dilemma

I am doing much more research on the output-gap elasticity problem of the deficit. One of the interesting findings I have encountered along the way is a dilemma for public finance:

In an economy with high pre-tax income inequality, the policy maker faces a trade-off between after-tax income inequality and income tax revenue volatility. In an economy with low pre-tax income inequality, there is no such trade-off.

A short explanation: Given high pre-tax income inequality, the policy maker which chooses to use the tax system to redistribute and reduce after-tax income inequality will draw a large share of income tax revenues from the high end of the income distribution. This end also sees high volatility of income; therefore income tax revenues will be highly volatile.