Exploring the Heterogeneity of Other-regarding Preferences

This project studies the impact of heterogeneous other-regarding preferences on many issues, such as taxation, government revenue and income inequality. The first two chapters build upon the literature of relative income effects pioneered by Duesenberry (1949). This hypothesis says that the utility of an individual depends on not only his absolute income level, but also his relative income position. An individual gains utility if his income exceeds the income of most members in his comparison group and loses utility if his income falls below the income of most members in the group. Most previous studies consider either a symmetric or a simple version of asymmetric case. In contrast, chapter 1 uses the British Household Panel Survey (BHPS) to depict a broader heterogeneity: income-dependent relative income effects. Results suggest that one’s relative income effect indeed depends on one’s income level.

In chapter 2, we investigate the effect of these income-dependent relative income effects on an optimal income tax model. Simulation results show that the optimal tax system becomes more progressive to the extent that the relatively wealthy have stronger concerns regarding others’ income than the relatively poor. This is an important result because it may provide theoretical evidence that increasing progressivity can be efficiency-enhancing.

In chapter 3, we consider the effects of other-regarding preferences on equilibrium labor supply, tax revenue, and income inequality in a society where agents have heterogeneous skill levels and thus heterogeneous wage rates. Different from the previous two chapters, the model in this chapter is sufficiently flexible to allow the externality from agents who are “ahead” to differ in both magnitude and direction from those who are “behind.” Our findings have important implications for tax policy.