MGEC31H3 : Taxation
18 Aug 2010
School
Department
Course
Professor
1
1. Terms and Concepts
2. Optimal Taxes on Consumption
3. Optimal Taxes on Labour
4. Optimal Taxes on Capital
5. Tax Evasion
LEARNING OBJECTIVES
1. What are the essential features
of optimal taxes
2. What factors influence tax evasion
ECMC31 – TOPIC 4
OPTIMAL TAXATION
2
1. TERMS AND CONCEPTS
3
Requirements
efficiency
o minimum excess burden
o minimum compliance costs
o minimum administrative costs
4
Requirements, continued
optimal taxes balance efficiency with fairness
fairness principles are subjective and may include
o horizontal equity
o vertical equity
o benefit principle
o minimum tax evasion
o inter-generational equity
equity = fairness
www.notesolution.com
5
Defining optimal taxes
economics => prescribes efficient taxes
value judgments => prescribe fairness
specified values
+ => prescribe optimal taxes
economics
different values will lead to different versions of
“optimal” taxes
fairness principle illustrated in the remainder of
this topic is “utilitarianism”
o place equal value on everyone’s utility
o try to maximize the sum of everyone’s
utility = maximize average utility
6
2. OPTIMAL TAXES
ON CONSUMPTION
7
Efficient commodity taxes
if income I is fixed,
a uniform, general, ad-valorem commodity tax
looks like a lump-sum tax => no EB
I = wL + rK = what we earn
income from capital ownership
income from work
but if L or K also fall in response to commodity
tax, then tax base I also falls and EB > 0
8
K = savings decision
your current income from capital came from a past
savings decision of yours
=> K = fixed in following short-run analysis
L = labour supply decision
Z = leisure decision
MAXT = total time available = L + Z
L changes when choice of leisure Z changes
thus I = wL + rK = w(MAXT - Z) + rK
= w·MAXT – wZ + rK
define potential income I* ≡ income from
working 24/7 plus your income from past
investment decisions = w·MAXT + rK, so I*= fixed
I is also what we spend on consumption,
i.e. I = PxX + PyY
so I* = PxX + PyY + wZ
fixed spending on spending on
income consumption leisure
A uniform ad-valorem tax on all consumption
plus leisure would act like a lump sum tax
with EB = 0. However, we can’t tax leisure.
www.notesolution.com
9
Ramsey Rule for efficient commodity taxation
tx, ty = ad valorem commodity taxes on X, Y
assume X and Y are consumed independently
=> EB = EBx + EBy
EBx = (1/2) εJx tx² (PxX)o for
MEBx = εJx tx small
EBy = (1/2) εJy ty² (PyX)o tax rates
MEBy = εJy ty
optimality criterion: set tax rates to make
marginal excess burdens equal: MEBx = MEBy
recall: εJ = εDεS /(εD+εS)
if supply is horizontal, i.e. production is constant
returns to scale (CRS), Ramsey Rule becomes
tx = εDy
ty εDx
Ramsey Rule = “inverse elasticity rule”
tx = εJy
ty εJx
10
Implications of the Ramsey Rule
1. Necessities can be taxed more heavily
than most discretionary goods
2. Addictive goods can be taxed more heavily
than most ordinary goods
examples?
are such taxes fair?
11
Corlett-Hague Rule
for efficient commodity taxation
tx, ty = ad valorem commodity taxes on X, Y
assume X ,Y are substitutes in consumption
w = wage-rate for labour = price of leisure
εXy = cross price elasticity of Py on X
= %∆X / %∆Py
εXw = cross price elasticity of wage-rate w on X
= %∆X / %∆w
note: tx = εyw + same
ty εxw + same
Corlett-Hague Rule for efficient tax rates
tx = εyw + εXy + εyx
ty εxw + εXy + εyx
12
Implications of the Corlett-Hague Rule
Goods connected with leisure can be taxed more
heavily than most goods connected with work
examples?
are such taxes fair?
www.notesolution.com
Document Summary
Learning objectives: what are the essential features of optimal taxes, what factors influence tax evasion. Requirements efficiency: minimum excess burden, minimum compliance costs, minimum administrative costs. 2 optimal taxes balance efficiency with fairness fairness principles are subjective and may include: horizontal equity, vertical equity, benefit principle, minimum tax evasion, inter-generational equity equity = fairness. Defining optimal taxes economics => prescribes efficient taxes value judgments => prescribe fairness specified values. + => prescribe optimal taxes economics different values will lead to different versions of. Optimal taxes fairness principle illustrated in the remainder of this topic is utilitarianism : place equal value on everyone"s utility, try to maximize the sum of everyone"s utility = maximize average utility. K = savings decision your current income from capital came from a past savings decision of yours. => k = fixed in following short-run analysis. Maxt = total time available = l + z.
