consumption level. It can, first, use education expenditures gɪ, and, second, use direct trans-
fers to redistribute income. We assume that the low-ability individuals are exempt from
taxation. The high-ability individuals have to pay a proportional tax t on their market
income. Total tax revenues are thus given by
T = tπ∏.
(3)
where π1 denotes the total income of the high-ability individuals as a group (i.e., the tax
base), and is given by
~h =
f Ph[A]aβi g1 β
JiIH
di = ph [A]aβ11 g11 β.
(4)
Note that the total income of the high-ability individuals is equal to their average income
because we have normalized the mass of this group to unity.
Given the above assumptions, the governments’s objective function, i. e. the net-consumption
of a representative individual belonging to the group of the low-ability individuals, is
Ж v = πι + MjZi r (5)
The net-consumption of a low-ability individual is thus given by her own market income π^,
and a per-capita transfer that is equal to the part of the tax revenues, R, used for the transfer
payments divided by the population mass of the low ability individuals.
2.2 Mobility and the optimal tax rate
It follows immediately from the objective function that the government should always choose
the highest possible tax rate. However, in reality, the government cannot freely choose the
tax rate because it has to take into account that high tax rates reduce the tax base. Emigra-
tion of the richly-endowed is one of the most important explanations for an upper limit on
redistribution through the tax-transfer system. Therefore, the equilibrium tax rate depends
on the extent of international mobility, which we presume in the following to be related to
the level of globalization.
We assume that these mobility decisions are made after production has taken place. This
implies that a high ability individual, if she chooses to emigrate, takes the income she has
already earned to the foreign country, but does not generate any additional income there.
To model these mobility decisions formally, let us presume that a high-ability individual
will be indierent between remaining in the country and emigrating if the following condition
holds:
(1 - t) πι = (1 - tF - æ[A]) πι,
(6)