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Direct or indirect tax instruments for redistribution: short-run versus long-run

  • Saez, Emmanuel

Optimal tax theory has shown that, under weak assumptions, indirect taxation such as production subsidies, tariffs, or differentiated commodity taxation, are sub-optimal and that redistribution should be achieved solely with the direct income tax. However, these important results of optimal tax theory, namely production efficiency and uniform commodity taxation under non-linear income taxation, have been shown to break down when labor taxation is based on income only and when there is imperfect substitution of labor types in the production function. These results in favor of indirect tax instruments are valid in the short-run when skills are exogenous and individuals cannot move from occupation to occupation. In the long-run, it is more realistic to assume that individuals choose their occupation based on the relative after-tax rewards. This paper shows that, in that context, production efficiency and the uniform commodity tax result are restored. Therefore, in a long-run context, direct income taxation should be preferred to indirect tax instruments to raise revenue and achieve redistribution.

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Article provided by Elsevier in its journal Journal of Public Economics.

Volume (Year): 88 (2004)
Issue (Month): 3-4 (March)
Pages: 503-518

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Handle: RePEc:eee:pubeco:v:88:y:2004:i:3-4:p:503-518
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  1. Naito, H., 1996. "Tariffs and Production Subsidies as Devices to Relax the Incentive Problem of a Progressive Income Tax System," Working Papers 391, Research Seminar in International Economics, University of Michigan.
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  16. Emmanuel Saez, 2000. "The Desirability of Commodity Taxation under Non-Linear Income Taxation and Heterogeneous Tastes," NBER Working Papers 8029, National Bureau of Economic Research, Inc.
  17. Gruber, Jon & Saez, Emmanuel, 2002. "The elasticity of taxable income: evidence and implications," Journal of Public Economics, Elsevier, vol. 84(1), pages 1-32, April.
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