This paper examines the optimal response of monetary and fi scal policy to a decline in aggregate demand. The theoretical framework is a two-period general equilibrium model in which prices are sticky in the short run and flexible in the long run. Policy is evaluated by how well it raises the welfare of the representative household. While the model has Keynesian features, its policy prescriptions di¤er signi cantly from textbook Keynesian analysis. Moreover, the model suggests that the commonly used "bang for the buck" calculations are potentially misleading guides for the welfare e¤ects of alternative fiscal policies.
This essay discusses the policy debate concerning optimal taxation and the distribution of income. It begins with a brief overview of trends in income inequality, the leading hypothesis to explain these trends, and the distribution of the tax burden. It then considers the normative question of how the tax system should be designed. The conventional utilitarian framework is found to be wanting, as it leads to prescriptions that conflict with many individuals’ moral intuitions. The essay then explores an alternative normative framework, dubbed the Just Deserts Theory, according to which an individual’s compensation should reflect his or her social contribution.
Should the income tax system include a tax credit for short taxpayers and a tax surcharge for tall ones? This paper shows that the standard Utilitarian framework for tax policy analysis answers this question in the a¢ rmative. Moreover, based on the empirical distribution of height and wages, the optimal height tax is substantial: a tall person earning $50,000 should pay about $4,500 more in taxes than a short person earning the same income. This result has two possible interpretations. One interpretation is that individual attributes correlated with wages, such as height, should be considered more widely for determining tax liabilities. Alternatively, if policies such as a tax on height are rejected, then the standard Utilitarian framework must in some way fail to capture our intuitive notions of distributive justice.