International Tax and Public Finance 3, 1996, pp. 259-280, CES Working Paper No. 102, January 1996, NBER Working Paper No. 5335, November 1995, Paper prepared for the 51 st IIPF Congress, Lisbon, August 1995, also in: P. B. Sorensen, ed., “Public Finance in a Changing World”, MacMillan Press: Houndmills 1998, pp. 73-99.
From the perspective of parents, redistributive taxation can be seen as social insurance for their children, for which no private alternative exists. Because private insurance comes too late during a person's life, it cannot cover the same risks as social insurance. Empirically, 85% of social insurance covers risks for which no private insurance would have been available. Redistributive taxation can be efficiency enhancing, because it creates safety and because it stimulates income generating risk taking. However, it also brings about detrimental moral hazard effects. Both the enhancement of risk taking and the moral hazard effects tend to increase the inequality in the economy, and, under constant returns to risk taking, this increase is likely to be strong enough even to make the net-of-tax income distribution more unequal. Optimal redistributive taxation will either imply that the pie becomes bigger when there is less inquality in pre-tax incomes or that more redistribution creates more post-tax inequality.
Social Insurance, Public Finance, Income Distribution, Private Insurance, Moral Hazard