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On the (Ir)Relevance of Distribution and Labor Supply Distortion to Government Policy

  • Louis Kaplow

Should the assessment of government policies, such as the provision of public goods and the control of externalities, deviate from first-best principles to account for distributive effects and the distortionary cost of labor income taxation? For example, is the optimal extent of public goods provision smaller than indicated by the Samuelson rule because finance is distortionary? Or should environmental regulations fail to internalize externalities fully if the incidence of the regulations is regressive? It is suggested that these questions are best addressed by considering distribution-neutral implementation, in which budget balance is achieved by choosing an adjustment to the income tax that offsets the distributive impact of the policy in question. In basic cases, both distribution and labor supply distortion are moot because the target policy and the tax adjustment produce offsetting effects on each. Thus, traditional first-best principles provide good benchmarks for policy analysis after all. Moreover, even when actual implementation will not be distribution neutral in aggregate, distribution-neutral policy analysis has many conceptual and practical virtues that render it quite useful to investigators.

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Article provided by American Economic Association in its journal Journal of Economic Perspectives.

Volume (Year): 18 (2004)
Issue (Month): 4 (Fall)
Pages: 159-175

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Handle: RePEc:aea:jecper:v:18:y:2004:i:4:p:159-175
Note: DOI: 10.1257/0895330042632726
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  1. Goulder, Lawrence H. & Parry, Ian W. H. & Williams III, Roberton C. & Burtraw, Dallas, 1999. "The cost-effectiveness of alternative instruments for environmental protection in a second-best setting," Journal of Public Economics, Elsevier, vol. 72(3), pages 329-360, June.
  2. Atkinson, A. B. & Stiglitz, J. E., 1976. "The design of tax structure: Direct versus indirect taxation," Journal of Public Economics, Elsevier, vol. 6(1-2), pages 55-75.
  3. Kaplow, Louis, 2006. "Public goods and the distribution of income," European Economic Review, Elsevier, vol. 50(7), pages 1627-1660, October.
  4. Konishi, Hideo, 1995. "A Pareto-improving commodity tax reform under a smooth nonlinear income tax," Journal of Public Economics, Elsevier, vol. 56(3), pages 413-446, March.
  5. Mirrlees, J. A., 1976. "Optimal tax theory : A synthesis," Journal of Public Economics, Elsevier, vol. 6(4), pages 327-358, November.
  6. Cordes, Joseph J. & Nicholson, Eric & Sammartino, Frank, 1990. "Raising Revenue by Taxing Activities with Social Costs," National Tax Journal, National Tax Association, vol. 43(3), pages 343-56, September.
  7. Hylland, Aanund & Zeckhauser, Richard, 1979. " Distributional Objectives Should Affect Taxes but not Program Choice or Design," Scandinavian Journal of Economics, Wiley Blackwell, vol. 81(2), pages 264-84.
  8. Sam Allgood & Arthur Snow, 1998. "The Marginal Cost of Raising Tax Revenue and Redistributing Income," Journal of Political Economy, University of Chicago Press, vol. 106(6), pages 1246-1273, December.
  9. Louis Kaplow, 2004. "On the Undesirability of Commodity Taxation Even When Income Taxation is Not Optimal," NBER Working Papers 10407, National Bureau of Economic Research, Inc.
  10. Charles L. Ballard & Don Fullerton, 1992. "Distortionary Taxes and the Provision of Public Goods," Journal of Economic Perspectives, American Economic Association, vol. 6(3), pages 117-131, Summer.
  11. Ballard, Charles L. & Medema, Steven G., 1993. "The marginal efficiency effects of taxes and subsidies in the presence of externalities : A computational general equilibrium approach," Journal of Public Economics, Elsevier, vol. 52(2), pages 199-216, September.
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