Social Status, Conspicuous Consumption Levies, and Distortionary Taxation

This paper explores the optimal tax structure in the presence of status effect. When the consumption of certain goods affects one’s social status, this creates an externality, which results in two opposite effects in a society. Seeking higher status through “positional goods” gives individuals much incentive to supply labor but still allocates income for less “nonpositional goods” as well. In this case, differentiated taxes on positional goods work as corrective instruments to internalize the social cost stemming from status seeking. Furthermore, the differentiated taxes generate revenue that can be used to alleviate preexisting income tax distortion. We develop a game-theoretic model in which each individual with different labor productivity unknown to the others engages in a status-seeking game, where government has a revenue requirement. Then we show that under a condition in which utility is separable between positional goods and leisure, a revenue-neutral shift in the tax mix away from nonlinear income taxes toward positional-good taxes enhances welfare. Hence, the differentiated taxes on positional goods are necessary together with the nonlinear income taxes for an optimal tax structure. Moreover, the differentiated taxes on positional goods could reduce the progressivity of the nonlinear income taxes, which is the case that can easily apply to practical use.