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The Dynamic Process of Tax Reform


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  • Alan Krause
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    The tax reform literature, pioneered by Guesnerie [1977], uses static models but views tax reform as a dynamic process, i.e., as a policy-maker implementing incremental reforms over time. This paper studies tax reform in a dynamic version of the Diamond-Mirrlees-Guesnerie model and focuses on a specific aspect of the dynamic process, namely, the implications for tax reform of agents leaving bequests. The main idea is that a tax reform in one period will affect bequests and therefore endowments, equilibrium, and welfare in subsequent periods. Thus, the process of tax reform cannot be analyzed as a sequence of static economies; instead, the economies are linked by bequests. The paper undertakes a tax reform analysis a la Guesnerie, but with an added focus on welfare improving reforms for each generation. Second-best Pareto optima are then characterized, and these conditions are compared to the static optimal tax formulae derived in the literature. In particular, the key Diamond-Mirrlees result that production efficiency is desirable at second-best optima no longer holds in the presence of (effective) restrictions on the taxation of private savings. Restrictions on government savings (including balanced budget restrictions), however, do not disturb the desirability of production efficiency. Finally, the effects of certain political constraints on the tax reform process are also consider

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    Paper provided by Econometric Society in its series Econometric Society 2004 Australasian Meetings with number 119.

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    Date of creation: 11 Aug 2004
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    Handle: RePEc:ecm:ausm04:119

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    Keywords: Dynamic tax reform; second-best Pareto optima; capital taxation;

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    1. King, Mervyn A., 1983. "Welfare analysis of tax reforms using household data," Journal of Public Economics, Elsevier, Elsevier, vol. 21(2), pages 183-214, July.
    2. Dixit, A.K., 1977. "Price Changes and Optimum Taxation in a Many-Consumer Economy," The Warwick Economics Research Paper Series (TWERPS) 117, University of Warwick, Department of Economics.
    3. Blackorby, Charles & Brett, Craig, 2000. "Fiscal Federalism Revisited," Journal of Economic Theory, Elsevier, Elsevier, vol. 92(2), pages 300-317, June.
    4. Weymark, John A., 1979. "A reconciliation of recent results in optimal taxation theory," Journal of Public Economics, Elsevier, Elsevier, vol. 12(2), pages 171-189, October.
    5. Fogelman Francoise & Guesnerie Roger & Quinzii Martine, 1977. "Dynamic processes for tax reform theory," CEPREMAP Working Papers (Couverture Orange) 7703, CEPREMAP.
    6. Ahmad, Ehtisham & Stern, Nicholas, 1984. "The theory of reform and indian indirect taxes," Journal of Public Economics, Elsevier, Elsevier, vol. 25(3), pages 259-298, December.
    7. Diewert, W. E., 1978. "Optimal tax perturbations," Journal of Public Economics, Elsevier, Elsevier, vol. 10(2), pages 139-177, October.
    8. Sushama Murty & R. Robert Russell, 2005. "Externality Policy Reform: A General Equilibrium Analysis," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 7(1), pages 117-150, 02.
    9. Michael Keen & David Wildasin, 2004. "Pareto-Efficient International Taxation," American Economic Review, American Economic Association, American Economic Association, vol. 94(1), pages 259-275, March.
    10. Peter A. Diamond & J. A. Mirrlees, 1968. "Optimal Taxation and Public Production," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 22, Massachusetts Institute of Technology (MIT), Department of Economics.
    11. Hu, Sheng Cheng, 1979. "Social Security, the Supply of Labor, and Capital Accumulation," American Economic Review, American Economic Association, American Economic Association, vol. 69(3), pages 274-83, June.
    12. Blackorby, Charles & Brett, Craig, 2004. "Capital Taxation In A Simple Finite-Horizon Olg Model," The Warwick Economics Research Paper Series (TWERPS) 709, University of Warwick, Department of Economics.
    13. Brett, Craig, 1998. "Tax reform and collective family decision-making," Journal of Public Economics, Elsevier, Elsevier, vol. 70(3), pages 425-440, December.
    14. Guesnerie, Roger, 1977. "On the direction of tax reform," Journal of Public Economics, Elsevier, Elsevier, vol. 7(2), pages 179-202, April.
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