rosenchap014 optimal taxation 2
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1
Chapter 14 Efcient and
Equitable Taxation
Public Finance
McGraw-Hill/Irwin 2005 The McGraw-Hill Companies, Inc., All Righ
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Optimal Commodity Taxation
Assume that the oal is to !nanceexpenditures "ith a minimum o#excess burden$
Assume lump sum taxes arein#easible$
Three commodities% &ood '( )( and leisure
Prices P'( P)( and "$
*
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Optimal Commodity Taxation
Time endo"ment is !xedat%
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The full budget constraint can be
written as:
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Optimal Commodity Taxation%
Case 1 All &oods Can ,e Taxed -# all commodities can be taxed(
imposin equal ad./alorem tax rates
yields%
4
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Optimal Commodity Taxation%
Case 1 All &oods Can ,e Taxed
-n this case( the inability to impose alump sum tax is irrele/ant$
The o/ernment can e0ecti/ely taea"ay a lump sum amount throuhequal taxes on all commodities
2includin leisure3$
o excess burden$
5
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Optimal Commodity Taxation%
Case * ot All &oods Can ,e Taxed
6ay be impossible to tax non.maret"or$
Assume only taxes can be applied tooods ' and )$
-n eneral( some excess burden isine/itable$ 7ey question is ho" toselect rates on ' and ) to minimi8eexcess burden sub9ect to the re/enueconstraint$
:
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Optimal Commodity Taxation%
;amsey ;ule
Consider the idea o# marinal excess burden
The additional inefciency #rom
incrementally raisin a tax by a smallamount
Fiure 14$1 sho"s the initial excessburden as a trianle 2abc3 and the
marinal excess burden as atrape8oid 2#bae3
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Other Criteria #or Tax esin
Gori8ontal equity% People in equal positionsshould be treated equally
6easures represent outcomes o#peopleNs decisions( so it is difcult to!ure out "hether they "ere initiallyin equal position$
Costs o# runnin a tax system Tax e/asion Tax a/oidance
+@
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Tax E/asion
Ta) e!asionis #ailin to pay leally duetaxes$
Tax cheatin is difcult to measure andprobably mani#ests itsel# in a number o# "ays% 7eepin t"o sets o# boos 6oonlihtin #or cash
,arter eal in cash
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Tax E/asion
?uppose person cares only aboutmaximi8in expected income
&oal is to choose ;( the amount that ishidden #rom authorities
6arinal bene!t o# hidin income is the taxrate
Assume authorities randomly audit "ithprobability( R( and increasin penalty #orreater amounts hidden$
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Tax E/asion
Fiure 14$5 sho"s that optimalunderreportin occurs "hen theexpected marinal bene!t #romdoin so exceeds the marinal cost$ -mplications% Cheatin increases
"ith tax rates and decreases "ithen#orcement$
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Fiure 14$5
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Tax E/asion
-nores a number o# real."orld
aspects% Psycholoical costs o# cheatin
;is a/ersion
Bor choices Probabilities o# audit
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Efcient and Equitable Taxation% ;ecap
Optimal Commodity Taxation
All oods taxed Only some taxed
Hser Fees
Optimal -ncome Taxation Tax E/asion
+: