The Price of Egalitarianism

We compute the welfare cost of egalitarianism - a tax policy that equalizes wages for all. The benchmark "laissez-faire" economy has features a la Aiyagari (1994) with endogenous labor supply. A progressive income tax provides insurance against income risks but at the cost of efficiency: it undermines highly productive workers' incentives to work. We find that in an economy with the labor-supply elasticity of 1, the welfare cost of egalitarianism, measured in consumption-equivalence units, is only 1% as the welfare gain from insurance against income risks nearly offsets the efficiency loss from distorting labor effort. However, with an elastic labor supply, the welfare cost of egalitarianism is as large as 7.5% of steady state consumption.