NON-LEAKY BUCKETS - OPTIMAL REDISTRIBUTIVE TAXATION AND AGENCY COSTS

Economists generally have argued that income redistribution comes at a cost in aggregate income. We provide a counter-example in a model whe re private information gives rise to incentive constraints. In the mod el, a wage tax creates the usual distortion in labor-leisure choices, but the redistributive grants that it finances reduce a distortion in investment in higher education. We prove that simple redistributive po licies can yield Pareto improvements and increase aggregate income. In deed, redistributive policies are, under most circumstances, more effe ctive in increasing efficiency than corrective taxes or subsidies wher e higher education is beyond the reach of the poor.