Optimal Redistribution with Endogenous Social Norms

• Author: Robin W. Boadway,Nicolas‐Guillaume Martineau
• Published date: 01 July 2016
• DOI: http://doi.org/10.1111/sjoe.12156
• Date: 01 July 2016

Scand. J. of Economics 118(3), 524–556, 2016

DOI: 10.1111/sjoe.12156

Optimal Redistribution with Endogenous

Social Norms∗

Robin W. Boadway

Queen’s University, Kingston ON K7L 3N6, Canada

boadwayr@econ.queensu.ca

Nicolas-Guillaume Martineau

Glendon College, York University, Toronto ON M4N 3M6, Canada

ngmartineau@glendon.yorku.ca

Abstract

In this paper, we examine the effect of social norms on redistributive policies, where social

norms are reflected in the degree of work participation among the different skill classes. Parti-

cipation is driven both by the material incentives and heterogeneous preferences for leisure of

each skill class, and by an endogenous social norm. Results for optimal redistributive taxation

show that when the social norm enters as a benefit or cost for participants, participation

taxes are generally lower than in its absence. Multiple participation equilibria can occur, and

an engineered shift from a low- to a high-participation equilibrium can be Pareto-improving

in the long run.

Keywords: Distributive justice; optimal taxation; work participation

JEL classification:D63; H21

I. Introduction

In this paper, we study the consequences for optimal redistribution policy

of households’ responses to tax-transfer policy being affected by a social

norm, here a rule concerning work participation. This social norm either

encourages or deters cooperative (i.e., pro-social) behavior in work par-

ticipation decisions, based on what workers infer about the cooperative

behavior of others. In particular, a high level of labor market participation

is taken to indicate that most non-participants are not there out of choice

but out of necessity or bad luck. When participation rates are relatively

low, the inference is that many non-participants willingly choose not to

∗We particularly wish to thank three anonymous referees for their very pertinent and helpful

comments. We also thank Al Slivinsky for commenting on an earlier version of this paper,

Laurence Jacquet for her comments at CESifo Public Sector Meetings 2013, and seminar

participants at UQAM and CPEG 2012 – Concordia University.

CThe editors of The Scandinavian Journal of Economics 2015.

R. W. Boadway and N.-G. Martineau 525

participate, indicating a lack of effort. The corresponding moral reward, as

we shall refer to it, for abiding by the work standard induces participation

above or below what would result from purely self-interested behavior. We

consider what the presence of work participation norms implies for the

structure of optimal nonlinear income taxation, and how the planner can

pro-actively use redistribution policy to influence participation decisions,

and thereby indirectly alter social norms of work participation. On the one

hand, prevailing social norms – particularly whether the economy is in a

high- or low-participation equilibrium – constrain optimal participation tax

rates. On the other, social norms can be influenced by redistribution poli-

cies. In particular, an engineered shift from a low- to a high-participation

equilibrium can be Pareto-improving in the long run, provided the planner

is far-sighted enough to be willing to jolt the economy temporarily by

relatively non-redistributive policies.

Norms affecting work participation decisions are modeled so as to em-

body prevailing views of distributive justice. These can take two conflict-

ing forms, based upon leading works of philosophy (e.g., Rawls, 1971;

Nozick, 1974) and found in the recent economic literature (e.g., B´

enabou

and Tirole, 2006). Economic outcomes can be either viewed largely as

the result of luck, which justifies redistribution as a means of com-

pensating the less well-endowed, or attributed to effort, which calls for

less redistribution. This distinction is explored by Fleurbaey and Maniquet

(2011), who distinguish between the Principle of Compensation, according

to which individuals should be compensated for differences in characteris-

tics over which they have no control (such as innate ability), and the Prin-

ciple of Responsibility, which holds that they should be neither rewarded

nor penalized for outcomes for which they are responsible through their

actions.

We study optimal nonlinear income taxation in an augmented version

of the well-known extensive margin model of Diamond (1980) and Saez

(2002). This model is useful to us in that it captures elegantly the indi-

viduals’ work participation decisions, which is arguably the margin most

relevant for addressing considerations about work norms being influenced

by transfers, while abstracting from any general equilibrium effects on

wages, or other margins of work participation (e.g., hours of work, oc-

cupational choices, etc.). In our version of the model, participation is

affected not only by personal preferences for work or leisure, but also

by social norms influenced by others’ participation decisions. We distin-

guish between social norms that affect the utility of participation, either

as an incitement or a deterrent, and those that affect non-participants,

for example, via stigmatization. Our analysis yields the following results.

When the social norm affects participants, optimal participation tax rates

will be lower relative to the case where social norms are absent. This

CThe editors of The Scandinavian Journal of Economics 2015.

526 Optimal redistribution with endogenous social norms

result is attributable to how a change in the tax incentives to participate

is compounded by the presence of the social norm, which makes partici-

pation more responsive. This does not however necessarily hold when the

social norm enters as a cost for non-participants. A higher participation

tax than in the case without a social norm may result if the planner suffi-

ciently cares about the welfare of non-participants, and the feedback effects

of the social norm on participation and budgetary balance are relatively

mild.

We also show how the social norm can lead to the existence of multiple

locally stable equilibria in work participation. Transitions between high- and

low-participation equilibria can be induced by changes in the progressivity

of the income tax schedule. Conditions for the Pareto-dominance of a high-

participation equilibrium over its low-participation counterpart are derived,

and are shown to constrain the choices of a social planner engineering a

transition from the latter to the former equilibrium. This requires reducing

the prevailing extent of redistribution compared with the (unconstrained)

optimal tax problem.

In our paper, cooperative behavior is fostered or discouraged by a social

norm that influences work participation decisions. Influential work on social

norms by Akerlof (1980) examined how they can drive the wage-setting

process, leading to a “fair” wage being chosen (rather than a market-

clearing wage) and involuntary unemployment. Social norms have been

shown to explain deviations from purely rational and self-interested be-

havior, for instance in the context of tax evasion (Gordon, 1989; Myles

and Naylor, 1996), and to reconcile theoretical results with conflicting

empirical evidence. They have also recently been shown to matter in the

context of the intensity of labor supply (Cervellati et al., 2010). They can

then serve to explain certain politico-economic attitudes towards redistri-

bution that standard models (e.g., Meltzer and Richard, 1981) cannot: for

instance, how economies with similar initial income distributions and so-

cial preferences can still differ in their chosen levels of redistribution and

their degree of social cohesion, as measured by the individuals’ compli-

ance with the work-hours norm. Such norms concerning the intensity of

labor supply – and its interaction with a participation norm – were also

applied to the context of optimal income taxation by Aronsson and Sj¨

ogren

(2010).

Other authors have invoked social norms to explain the compounding

of moral hazard effects caused by the welfare state’s social programs

(Lindbeck, 1995; Lindbeck et al., 1999, 2003; Dufwenberg and Lundholm,

2001; Lindbeck and Nyberg, 2006). The context for these analyses was a

reconsideration of the welfare state in Europe, following persistently low

levels of work participation, and correspondingly high levels of benefit

claims. This was deemed to result from a weakening of norms – either

CThe editors of The Scandinavian Journal of Economics 2015.