Optimum Distortions in Closed and Open Economies: Some Aspects of the Theory of Second Best

Substantial advance has been made in the exploration of optimum policies in a given economic environment. The Theory of Second Best has been quite a challenging field of research particularly since the publication of the excellent paper by Lipsey and Lancaster (1956), and it has been extended over to the open economies by the powerful pencrafts of Corden (1957), Bhagwati and Ramaswami (1985), Johnson (1965), Ghosh (1979), and many others. In the framework of the closed economies very many crops have been available at intervals. But what have been found so far are various piecemeal researches and findings for the economic society striving for better economic conditions in the imperfect market setting through different possible measures of policy manipulation, and, therefore, what is lacking is a coherent structure of optimum distortions. In this chapter we build the structure of optimum distortions in different postulated set-ups. First, we discuss possible tax structure in closed and open economic frameworks, and then try to ascertain when uniform rather than differentiated and when differentiated rather than uniform tax structure would be optimal for the taxing country. This issue of uniform versus non-uniform tax system has been important in consideration of economic efficiency, equity and administrative simplicity for quite a long time, and, therefore, we would like to look into it in some detail. Here we consider only one factor of production, labour measured in units of man-hour.