Does inequality shape society? This thesis proposes to consider inequality as an economic externality by inserting an inequality measure into the individual utility function. The externality is largely distinct from other conventional inequality consid- erations, and directly captures both (i) societal e_ects of inequality and (ii) individual distributional preferences. It has large theoretical implications: the Atkinson-Stiglitz theorem no longer holds, as goods consumed by low- and high-income agents are op- timally subsidized and taxed, respectively. The First Welfare theorem falls away, and the Mirrlees (1971) optimal income taxation model changes drastically. An appropri- ate externality can bene_t public policy by reconciling di_erences between economic theory and current tax systems. To motivate the discussion, the existing empirical evidence for an inequality externality is critically examined.