1997 Reports

Taxes Versus Legal Rules as Instruments for Equity

Sanchirico, Chris William

Kaplow and Shavell (1994) show that legal rules should not be made contingent upon the income (wealth, consumption, occupation, etc. . . .) of the parties and conclude from this that "it is appropriate for economic analysis of legal rules to focus on efficiency and ignore the distribution of income". We accept the validity and importance of their argument against conditioning legal rules on these otherwise taxable attributes. But we argue against their apparent conclusion that legal rules should be set according to efficiency considerations alone. Using a slight modification of their own model, we find that: 1) even in the presence of an optimal income tax, any concern for equity dictates that legal rules deviate from efficient standards in a manner that aids the less well-off-this, so long as there is any heterogeneity in the way that agents respond to the legal system; 2) when, in addition, income difference are predominant in overall inequality, legal rules should in fact be adjusted away from efficient standards in a manner that helps low-income individuals; 3) under certain additional conditions, legal rules should be specifically adjusted to correct income-based inequality-legal rules should not be made contingent on parties income on a case-by-case basis, but they should be adjusted across the board in a manner that counteracts income inequality. Our broader point is that there is no a priori reason to favor any one economic activity over another-leisure choice over care choice, for instance-in accomplishing redistributional goals. The optimal redistributional program will involve a mixture of methods and deviations from efficiency in one domain may even be used to correct inequalities arising in another. We conclude that the extent to which legal rules should be used for redistributional purposes must be settled empirically and /or on the basis of factors outside the scope of Kaplow and Shavell's (1994) analysis.