Nonlinear pricing, redistribution, and optimal tax policy

This paper examines the role of nonlinear pricing by public ~or regulated! utilities as a redistributive mechanism in presence of an optimal nonlinear income tax. It models an economy with many types of persons who differ in two unobservable characteristics ~earning abilities and tastes!. We show that nonlinear pricing does have a redistributive role; it is not a substitute for an illdesigned tax policy. We prove, assuming separable preferences, that a person whose valuation of the public sector output is smaller than the average valuation of the population (all measured at the same consumption bundle) must face a marginal price for the good above its marginal cost. Further assuming that tastes and earning abilities are perfectly correlated, we prove that everyone must face a marginal price for the public sector's output which strictly exceeds its marginal cost if correlation is positive. These properties provide an economic rationale for the provision of "support for low-income consumers" as mandated by the universal service and similar regulatory policies. Finally, we show that with correlated characteristics, implementation can be achieved through two separate functions: a pricing function that depends only on the public sector output and a tax function that depends only on income.