Relational Contracts, Taxation and the Household

This paper applies the theory of relational contracts to make precise the idea that because households are engaged in a repeated non-cooperative game, Pareto efficient outcomes can be supported by self interest, given the specific pattern of specialisation and exchange which exists in the household. The household's choice of a particular solution from the resulting feasible set is found by the maximisation of a household welfare function, a generalisation of a suggestion originally made by Samuelson. This nests as special cases the objective functions used in currently popular models of households engaged in one-shot cooperative games. We take a specific example of such a household welfare function, characterise the determinants of the household utility distribution, and then apply the model to examine the effects of a move from joint to individual taxation. We show that on standard stylised facts, secondary earners are always better off absolutely, and define the conditions under which they will also be so relatively. This confirms the conclusions from models which concern themselves only with the across-household welfare distribution.