Optimal Income Taxation and Public Good Provision with Endogenous Interest Groups

This paper studies public goods provision when agents differ in earning abilities as well as preferences. Heterogeneity in skills makes redistribution desirable and generates an equity‐efficiency trade‐off. If tax revenues are devoted to a public good, this trade‐off is affected in such a way that income transfers are less desirable. High‐skilled individuals thus have an incentive to exaggerate their preferences for public goods. Analogously, low‐skilled individuals lobby against public good provision. A requirement of collective incentive compatibility eliminates these biases. It implies that income transfers are increased whenever a public good is provided and are decreased otherwise.