Welfare Effects of Tax and Price Changes Revisited
AbstractDixit’s 1975 paper "Welfare Effects of Tax and Price Changes" constitutes a seminal contribution to the theory of tax reform analysis within a second-best general equilibrium framework. The present paper clarifies ambiguities with respect to normalisation which have 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, and shows that this result provides the key to understanding what determines the optimal system of commodity taxation as reflected in the Corlett and Hague analysis of optimal taxation in an economy with two produced commodities. Recasting work by Deaton (1981b), it generalises, using an alternative definition of the complementarity between consumption and leisure, to an economy with many commodities the insight that the optimal tax system is determined as a trade-off between two objectives: 1) to encourage the supply of labour to the market, and 2), to limit the distortion of the pattern of consumption of produced commodities. This insight cannot be illustrated by simulation studies using standard additive separable utility functions. However, extending work of Atkinson and Stern (1980, 1981) the paper presents 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. This functional form is used to provide a quantitative illustration of the trade-off which defines the optimal tax system and thus desirable directions of tax reform.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by School of Economics and Management, University of Aarhus in its series Economics Working Papers with number 2008-03.
Date of creation: 08 Feb 2008
Date of revision:
Contact details of provider:
Web page: http://www.econ.au.dk/afn/
Public economics; optimal taxation; tax reform; tax simulation; distance functions; CGE models;
Other versions of this item:
- Knud J., MUNK, 2008. "Welfare Effects of Tax and Price Changes Revisited," Discussion Papers (ECON - DÃ©partement des Sciences Economiques) 2008006, Université catholique de Louvain, Département des Sciences Economiques.
- H2 - Public Economics - - Taxation, Subsidies, and Revenue
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Munk, Knud Jorgen, 1978. " Optimal Taxation and Pure Profit," Scandinavian Journal of Economics, Wiley Blackwell, vol. 80(1), pages 1-19.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.