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Indirect taxes for redistribution: should necessity goods be favored?

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  • BOADWAY, Robin

    ()
    (Queen’s University, Canada & CESifo)

  • PESTIEAU, Pierre

    ()
    (Université catholique de Louvain, CORE, B-1348 Louvain-la-Neuve, Belgium and Université de Liège, B-4000 Liège, Belgium)

Abstract

The Atkinson-Stiglitz Theorem shows that with weakly separable preferences, differential commod- ity taxes are not needed if an optimal nonlinear income tax is imposed. Redistributive objectives can be achieved with the income tax alone even if goods differ considerably in their income elasticities of demand. Deaton showed that if the government is restricted to a linear progressive income tax along with commodity taxes, the latter are superfluous if preferences are not only weakly separable but also yield linear Engel curves whose slopes are common to all households. These have potentially strong policy implications since they suggest that the common practice of giving preferential commodity tax treatment to necessities is not warranted. Using the linear progressive income tax as an example and assuming the Deaton conditions are satisfied, we derive two contradictory results. First, if the income tax is less progressive than optimal, necessities should be taxed preferentially relative to luxuries. Second, if low-income households are income-constrained so are unable to afford any luxury goods, it may be optimal to tax necessity goods at higher rates than luxuries, depending on whether labor supply varies along the intensive or extensive margin. The analysis is extended to allow for nonlinear taxes and endogenous demand for a public good.

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Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2011066.

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Date of creation: 31 Dec 2011
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Handle: RePEc:cor:louvco:2011066

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Keywords: optimal income tax; Atkinson-Stiglitz Theorem; indirect taxes;

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  1. Bas Jacobs, 2010. "The Marginal Cost of Public Funds is One," CESifo Working Paper Series 3250, CESifo Group Munich.
  2. Boadway, Robin & Gahvari, Firouz, 2006. "Optimal taxation with consumption time as a leisure or labor substitute," Journal of Public Economics, Elsevier, vol. 90(10-11), pages 1851-1878, November.
  3. Richard Arnott & Bruce Greenwald & Ravi Kanbur & Barry Nalebuff (ed.), 2003. "Economics for an Imperfect World: Essays in Honor of Joseph E. Stiglitz," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262012057, December.
  4. Cremer, Helmuth & Gahvari, Firouz, 1995. "Uncertainty, Optimal Taxation and the Direct versus Indirect Tax Controversy," Economic Journal, Royal Economic Society, vol. 105(432), pages 1165-79, September.
  5. Sheshinski, Eytan, 1972. "The Optimal Linear Income-Tax," Review of Economic Studies, Wiley Blackwell, vol. 39(3), pages 297-302, July.
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