Positional Concerns in an OLG Model: Optimal Labor and Capital Income Taxation

This paper concerns optimal income taxation under asymmetric information in a two-type overlapping generations model, where people care about their relative consumption compared to others.

The appearance of positional concerns affects the policy choices via two channels: (i) the size of the average degree of positionality and (ii) positionality differences between the (mimicked) low-ability type and the mimicker. Under plausible empirical estimates, the marginal labor income tax rates become substantially larger, and the absolute value of the marginal capital income tax rate implemented for the low-ability type becomes substantially smaller, compared to the conventional optimal income tax model. In addition to measures of reference consumption based on the average consumption, results for the cases of withingeneration and upward comparisons are also presented.