In this chapter, the following content will be discussed: Optimal tax theory uses the tools of welfare economics to provide another view of the efficiency and equity considerations of tax design. In general, taxes: Should have horizontal and vertical equity, should be neutral concerning economic incentives, should be administratively easy, should have low compliance costs. | EFFICIENT AND EQUITABLE TAXATION Chapter 16 Optimal Commodity Taxation w(T – l) = PXX + PYY wT = PXX + PYY + wl wT = (1 + t)PXX + (1 + t)PYY + (1 + t)wl 1 wT = PXX + PYY + wl 1 + t 16- The Ramsey Rule X per year PX DX P0 X0 c P0 + uX b X1 ∆X a Excess Burden P0 + (uX + 1) f X2 i ∆x e j h g Marginal Excess Burden marginal excess burden = area fbae = 1/2∆x[uX + (uX + 1)] = ∆X 16- The Ramsey Rule Continued change in tax revenues = area gfih – area ibae = X2 – (X1 – X2)uX marginal tax revenue = X1 ∆X marginal tax revenue per additional dollar of tax revenue = ∆X/(X1 - ∆X) marginal tax revenue per additional dollar of tax revenue for good Y = ∆Y/(Y1 - ∆Y) To minimize overall excess burden = ∆X/(X1 - ∆X) = ∆Y/(Y1 - ∆Y) therefore 16- A Reinterpretation of the Ramsey Rule inverse elasticity rule 16- The Corlett-Hague Rule In the case of two commodities, efficient taxation requires taxing commodity complementary to leisure at a relatively high rate | EFFICIENT AND EQUITABLE TAXATION Chapter 16 Optimal Commodity Taxation w(T – l) = PXX + PYY wT = PXX + PYY + wl wT = (1 + t)PXX + (1 + t)PYY + (1 + t)wl 1 wT = PXX + PYY + wl 1 + t 16- The Ramsey Rule X per year PX DX P0 X0 c P0 + uX b X1 ∆X a Excess Burden P0 + (uX + 1) f X2 i ∆x e j h g Marginal Excess Burden marginal excess burden = area fbae = 1/2∆x[uX + (uX + 1)] = ∆X 16- The Ramsey Rule Continued change in tax revenues = area gfih – area ibae = X2 – (X1 – X2)uX marginal tax revenue = X1 ∆X marginal tax revenue per additional dollar of tax revenue = ∆X/(X1 - ∆X) marginal tax revenue per additional dollar of tax revenue for good Y = ∆Y/(Y1 - ∆Y) To minimize overall excess burden = ∆X/(X1 - ∆X) = ∆Y/(Y1 - ∆Y) therefore 16- A Reinterpretation of the Ramsey Rule inverse elasticity rule 16- The Corlett-Hague Rule In the case of two commodities, efficient taxation requires taxing commodity complementary to leisure at a relatively high rate 16- Equity Considerations Equity implications of inverse elasticity rule Vertical equity Optimal departure from Ramsey Rule 16- Application: Taxation of the Family Under federal income tax law, fundamental unit of income taxation is family Is excess burden minimized by taxing each spouse’s income at same rate? Should husbands face higher marginal tax rates than wives? 16- Optimal User Fees Z per year $ A Natural Monopoly DZ MRZ ACZ MCZ ZM PM ACM Z* P* ZA Marginal Cost Pricing with Lump Sum Taxes Benefits received principle Average Cost Pricing A Ramsey Solution 16- Optimal Income Taxation— Edgeworth’s Model W = U1 + U2 + + Un Individuals have identical utility functions that depend only on their incomes Total amount of income fixed Implications of model for income tax 16- Optimal Income Taxation— Modern Studies Supply-side responses to taxation Linear income tax model (flat income tax) Revenues = -α + t * Income Mankiw, Weinzierl, Yagan [2009] .
