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Optimal Tax Mix in a Two-Sector Growth Model with Transitional Dynamics

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Author Info
James B. Davies (The University of Western Ontario Department of Economics)
Jie Zhang
Jinli Zeng

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Abstract

This paper examines the problem of optimal tax mix analytically in a two-sector growth model with transitional dynamics. Tax revenue is required to provide a pure public good. The key problems are: over-consumption of leisure under labor income or consumption taxes; and under-investment in human and physical capital under income taxes. Without investment subsidies, consumption taxes do better than uniform income taxes, but can be improved on locally via positive taxation of physical capital income and a negative tax on labor income. With subsidies the first best can be achieved in a system where: (i) consumption and labor income taxes are either zero or of the same rate but opposite signs; (ii) physical capital income taxes are used either exclusively or more heavily than labor income taxes when their rates are below 100%; and (iii) investment subsidy rates equal income tax rates for both forms of capital, respectively. In any given circumstances, a range of alternative tax mixes may provide equivalent results. This result, combined with practical constraints, may help to explain the variety of tax mixes observed across countries.

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Paper provided by University of Western Ontario, Department of Economics in its series UWO Department of Economics Working Papers with number 200017.

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Date of creation: Dec 2000
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Handle: RePEc:uwo:uwowop:200017

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Cited by:
(explanations, 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.)

  1. Kirk A. Collins & James Davies, 2003. "Measuring Effective Tax Rates on Human Capital: Methodology and an Application to Canada," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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