The organization of the paper is as follows. Section 2 introduces the basic
framework. In section 3 we characterize the equilibrium. The succeeding section
examines the optimal tax treatment of charitable contributions. Section 5 concludes.
2. The Model
Consider an economy with a continuum of individuals (whose number is
normalized to one), producing a single consumption-good. Following Mirrlees (1971)
we assume that individuals differ in their innate ability denoted by w (which also
denotes the hourly wage rate in the competitive labor market). The production-
technology employs labor only and exhibits constant returns to scale and perfect
substitutability among various skill levels. We further assume that the innate ability is
distributed according to some cumulative distribution functionF(w) with the support
- [ w, w ].
As in Mirrlees (1971), all individuals share the same preferences, which are
represented by the following utility function:
(1) U ( c, l, z, g ) = β∙ p ( z ) ∙ b + u ( c ) + h ( l ) + (1 - β) ∙ v ( z ) + α∙r ( g ),
where c denotes consumption, l denotes leisure, z denotes charitable contribution and
g denotes public good provision; the functions u, h, v and r are assumed to be strictly
concave and strictly increasing; b > 0, α> 0 and 0 ≤ β≤ 1 .
The utility specification given in (1) captures the two contribution motives
discussed in the introduction. The altruistic motive is captured by the function v which
measures the joy of giving ('warm glow' effect). The strategic motive to signal ability
and thereby gain social status was first investigated by Glazer and Konrad (1996). In
our framework it is captured by the first term on the right-hand side of equation (1).
To see this observe that for analytical tractability we assume a two (status) class