Prague Economic Papers 2020, 29(5):575-599 | DOI: 10.18267/j.pep.750

Social Welfare Effects of Progressive Income Taxation under Increasing Inequality

Saša Ranđelovića, Marko Vladisavljevićb
a University of Belgrade, Faculty of Economics, Belgrade, Serbia
b Institute of Economic Sciences, Serbia

During the 2008 economic crisis, labour market inactivity, unemployment and work informality in Serbia rose substantially, triggering a salient increase in Gini-measured inequality (by 4.3 pp), while income tax progressivity remained very low. Using the micro-simulation and utility function estimation techniques on 2007 and 2012 household survey data for Serbia, we compare the social welfare effects of a hypothetical shift from flat to progressive taxation, before and after the crisis. We find that a shift from flat to progressive tax and the consequent behavioural response lead to a reduction in inequality, a rise in total labour supply and an increase in the overall social welfare in both years. Although the decrease in inequality is higher in 2012, the overall welfare effects are slightly larger in 2007, due to the stronger labour supply response and the stronger disutility of work found in the latter year. This may suggest that a rise in inequality does not per se create a stronger case for progressive taxation, as the welfare effects are considerably driven by the structure of income-leisure preferences.

Keywords: Optimal income taxation, tax progressivity, inequality, labour supply, social welfare
JEL classification: H21, H24, J22

Received: January 20, 2019; Revised: November 11, 2019; Accepted: February 13, 2020; Prepublished online: June 24, 2020; Published: October 16, 2020  Show citation

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Ranđelović, S., & Vladisavljević, M. (2020). Social Welfare Effects of Progressive Income Taxation under Increasing Inequality. Prague Economic Papers, 29(5), 575-599. doi: 10.18267/j.pep.750
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