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The Mainstream Notion of ‘Deadweight Loss of Taxation’ Is Based on Too Stringent (Misleading) Assumptions

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  • Cristian Sepulveda

    (Farmingdale State College, SUNY, USA)

Abstract

Mainstream optimal tax theory considers the lump-sum tax as the only efficient or non-distortionary tax instrument, and as such, the only tax instrument that is never associated with a deadweight loss. This paper challenges this notion, which is shown to depend on the assumption that public expenditure has no effect on taxpayers’ budget constraints. When this assumption is relaxed, the combined use of labor income and lump-sum taxes may allow taxpayers to reach greater levels of welfare than the use of a lump-sum tax alone. In that case, the labor income tax would be part of the (first best) welfare maximization solution and its effect on the relative price of leisure would therefore correspond to a price correction, not a distortion.

Suggested Citation

  • Cristian Sepulveda, 2020. "The Mainstream Notion of ‘Deadweight Loss of Taxation’ Is Based on Too Stringent (Misleading) Assumptions," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper2003, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
    • Handle: RePEc:ays:ispwps:paper2003
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    File URL: https://icepp.gsu.edu/files/2020/03/paper2003.pdf
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