Welfare Effects of Tax and Price Changes and the CES-UT Utility Function
AbstractDixit’s 1975 paper "Welfare Effects of Tax and Price Changes" constitutes a seminal contribution to the theory of tax reform within a second-best general equilibrium framework. The present paper clarifies ambiguities with respect to normalisation which has led to misinterpretation of some of Dixit’s analytical results. It proves that a marginal tax reform starting from a proportional tax system will improve social welfare if it increases the supply of labour, whatever the rule of normalisation adopted. In models which impose additive separability between consumption and leisure in household preferences this insight cannot be articulated. This paper proposes as an alternative a parameterised utility function with explicit representation of the use of time, the CES-UT, which allows a flexible representation of the relationship between consumption and leisure. It also demonstrates how standard compensated price elasticities can be derived from the parameters of the CES-UT and how it may be used for applied tax reform analysis.
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Bibliographic InfoPaper provided by School of Economics and Management, University of Aarhus in its series Economics Working Papers with number 2006-15.
Date of creation: 30 Dec 2006
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Public economics; optimal taxation; tax reform; tax simulation; CGE models;
Find related papers by JEL classification:
- H2 - Public Economics - - Taxation, Subsidies, and Revenue
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-02-10 (All new papers)
- NEP-PBE-2007-02-10 (Public Economics)
- NEP-UPT-2007-02-10 (Utility Models & Prospect Theory)
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- Knud Munk, 2008.
"Tax-tariff reform with costs of tax administration,"
International Tax and Public Finance,
Springer, vol. 15(6), pages 647-667, December.
- Knud Jørgen Munk, 2005. "Tax-tariff reform with costs of tax administration," Economics Working Papers 2005-21, School of Economics and Management, University of Aarhus.
- Knud Jørgen Munk, 2006. "Tax-tariff reform with costs of tax administration," Economics Working Papers 2006-14, School of Economics and Management, University of Aarhus.
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