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The Substantial Bias from Ignoring General Equilibrium Effects in Estimating Excess Burden, and a Practical Solution

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Author Info
Lawrence H. Goulder
Roberton C. Williams III

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Abstract

We show that under typical conditions the simple "excess-burden triangle" formula substantially underestimates the excess burden of commodity taxes, in some cases by a factor of 10 or more. This formula performs poorly because it ignores general equilibrium interactionsmost important, interactions between the taxed commodity and the labor market. Many prior studies have shown that general equilibrium interactions affect excess burden but have not appreciated the bias associated with ignoring these interactions or the quantitative importance of this bias. We derive an implementable alternative to the simple formula. This alternative formula captures interactions that the simple formula omits; as a result it is both unbiased and usually more accurate.

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Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 111 (2003)
Issue (Month): 4 (August)
Pages: 898-927
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Handle: RePEc:ucp:jpolec:v:111:y:2003:i:4:p:898-927

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