Keeping up with the Joneses, the Smiths and the Tanakas: On International Tax Coordination and Social Comparisons

Abstract

Much evidence suggests that between-country social comparisons have become more important over time due to globalization. This paper analyzes optimal income taxation in a multi-country economy, where consumers derive utility from their relative consumption compared with both other domestic residents and people in other countries. The optimal tax policy in our framework reflects both correction for positional externalities and redistributive aspects of such correction due to the incentive constraint facing each government. If the national governments behave as Nash competitors to one another, the resulting tax policy only internalizes the externalities that are due to within-country comparisons, whereas the tax policy chosen by the leader country in a Stackelberg game also to some extent reflects between-country comparisons. We also derive globally efficient tax policies in a cooperative framework, and conclude that there are potentially large welfare gains of international tax policy coordination resulting from cross-country social comparisons.