rosenchap014 optimal taxation 2

7/24/2019 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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Time endo"ment is !xedat%

+

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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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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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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;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

+1


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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

+5


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Efcient and Equitable Taxation% ;ecap


All oods taxed Only some taxed

Hser Fees

Optimal -ncome Taxation Tax E/asion

+:

rosenchap014 optimal taxation 2

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