International Externalities in the Use of Policies for Income Redistribution

by

Alan V. DEADROFF

Abstract

Policies to redistribute income between high- and low-income groups are well known to distort factor supply decisions and thereby to generate deadweight losses incidental to income redistribution.
This paper will examine the effects that these same distortions may also have on factor supplies themselves, and thus on the implied patterns of production and international trade.
The point is not just that redistribution policies may matter for trade, however, but that, through their effects on world market prices and associated factor prices, the distributional effects of redistribution policies spill over into the markets of a country's trading partners.
Using a standard two-factor, two-good Heckscher-Ohlin Model with endogenous factor supplies of skilled and unskilled labor, the paper will derive the effects of a progressive income tax on factor supplies, production, trade, world goods markets, and factor markets at home and abroad.
One expected result is that a progressive income tax by a large country is to some extent undermined in its effects on the income distribution by changes in world prices, and also that such a policy tends to worsen the income distribution abroad at the same time that it improves it at home.
Another result is that a progressive income tax will affect a country's terms of trade in ways that will sometimes reinforce, other times offset, the incentive to redistribute income.
Both results have implications for the need for, and desirability of, international coordination of policies for domestic income redistribution.