Working Papers in Economics,
University of Gothenburg, Department of Economics

Abstract: Almost all previous studies on public policy under relative consumption concerns have ignored the role of leisure for status comparisons. Inspired by Veblen (1899), this paper considers a two-type optimal income tax model, where people care about their relative consumption, and where the importance of relative consumption increases with the use of leisure due to increased consumption visibility. We show that increased consumption positionality typically implies higher marginal income tax rates for both ability-types. Using a leisure-weighted measure of reference consumption, rather than a measure where leisure plays no role as in the previous literature, increases the marginal income tax rate implemented for the low-ability type and decreases the marginal income tax rate implemented for the high-ability type, i.e., it gives rise to a regressive tax component.

Keywords: optimal taxation; redistribution; public goods; relative consumption; status; positional goods

JEL-codes: D62; H21; H23; H41

30 pages, August 19, 2010

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