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Public policy, dynamic status preferences, and wealth inequality

Research output: Contribution to journalArticle

Evangelos V. Dioikitopoulos, Stephen J. Turnovsky, Ronald Wendner

Original languageEnglish
JournalJournal of Public Economic Theory
Early online date23 Aug 2018
DOIs
Publication statusE-pub ahead of print - 23 Aug 2018

King's Authors

Abstract

This paper studies the effect of productive government spending (taxation) on aggregate savings behavior and its consequences for the dynamics of wealth inequality, taking into consideration key behavioral changes that occur during the process of economic development. Substantial empirical evidence suggests that during this process agents' preferences toward status (positional consumption) evolves according to the average wealth of the society. The sources of wealth include private capital and productive public capital, the latter financed by a distortionary income tax. This dynamic status effect impacts peoples' responses to tax policy in ways which contrast with those of the standard neoclassical model. Specifically, we find that in response to an increase in the income tax, in economies with a strong (weak) enough dynamic status effect, savings and inequality increase (decrease). Incorporating the behavioral changes to fiscal policy expands the set of mechanisms available to explain the observed variations of savings and wealth distribution dynamics that cannot be attributed to technological or other structural factors.

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