Mobility, Taxation and Welfare

Income mobility is often thought to equalize permanent incomes and thereby to improvesocial welfare. The welfare analysis of mobility often fails, however, to account for the cost ofthe variability of periodic incomes around permanent incomes. This paper assesses the netwelfare benefit of mobility by assuming both a social aversion to inequality in permanentincomes and an individual aversion to variability in periodic incomes. The paper furtherinvestigates the combined (and comparative) impact of mobility and of the tax system(another presumed income equalizer) on the dynamics of income across time and on theinequality of income across individuals. Using panel data, we find that Canada’s tax systemlimits significantly the redistributive impact of mobility while also lowering considerably thecost of income variability. The permanent income equalizing effect of taxes can reach up to23 percent of mean income at the higher values of inequality aversion that we use. Globally,the net social welfare effect of both mobility and taxation is (almost always) positive andsubstantial, often amounting to around 30 percent of mean income. For all choices ofparameter values, the tax effect exceeds by far the net effect of mobility on inequality andsocial welfare....