How do indirect taxes reshape tax-benefit-revealed social preferences for redistribution?

Abstract

The inverse optimum taxation approach can uncover the implicit social preferences for redistribution, ‘revealed’ through the tax-benefit system. Preferences are represented by the marginal social welfare weights (MSWWs) attributed to individuals at different income levels, which measure the social value of redistributing a euro to those individuals. Studies typically uncover preferences revealed through direct taxes and benefits only, leaving out indirect taxes. This runs counter to the standard interpretation of taxes in the optimal income taxation literature, which does include indirect taxes. We consider them along with the direct part of the Croatian tax-benefit system to uncover the implicit MSWWs and compare them to the baseline MSWWs derived based on direct taxes and benefits only. The results indicate that adding indirect taxes has a non-trivial impact on the MSWWs, suggesting that considering only direct taxes and benefits may give an incomplete picture of tax-benefit-revealed redistributive preferences. We use a simple decomposition framework to account for the changes in MSWWs.