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Indirect Taxation and Progressivity: Revenue and Welfare Changes

Author

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  • John Creedy
  • Catherine Sleeman

Abstract

When debating an existing or proposed indirect tax, particular emphasis is often given to the disproportional effect of the tax. This effect is intended to show how the welfare loss from the tax is distributed across households with various income levels. Typically, the disproportional effect is assessed using a tax-revenue-based measure that computes how the amount of tax paid, expressed as a fraction of household expenditure, varies as household expenditure increases. However, the amount of tax paid by a household does not always form a good measure of the welfare loss experienced by the household. Hence a more appropriate assessment of the disproportional effect of a tax is a welfare-based measure that computes the variation in the welfare loss (from the tax) as a fraction of household expenditure, as household expenditure increases. This paper shows that when the households' preferences, in respect to their choice of goods, are allowed to vary among households, tax revenues provide a poor measure of disproportionality, producing results that directly conflict with those produced from a welfarebased measure. The New Zealand indirect tax system is used to show that such cases of conflict are frequent, reinforcing the importance of using a welfare-based measure when assessing the disproportional effects of an indirect tax.

Suggested Citation

  • John Creedy & Catherine Sleeman, 2006. "Indirect Taxation and Progressivity: Revenue and Welfare Changes," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 62(1), pages 50-67, March.
  • Handle: RePEc:mhr:finarc:urn:sici:0015-2218(200603)62:1_50:itapra_2.0.tx_2-4
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    References listed on IDEAS

    as
    1. John Creedy, 1998. "Measuring Welfare Changes and Tax Burdens," Books, Edward Elgar Publishing, number 1579, September.
    2. John Creedy & Cath Sleeman, 2005. "Excise taxation in New Zealand," New Zealand Economic Papers, Taylor & Francis Journals, pages 1-35.
    3. Creedy, John, 1998. "Measuring the Welfare Effects of Price Changes: A Convenient Parametric Approach," Australian Economic Papers, Wiley Blackwell, pages 137-151.
    4. Deaton,Angus & Muellbauer,John, 1980. "Economics and Consumer Behavior," Cambridge Books, Cambridge University Press, number 9780521296762, December.
    5. R. A. Musgrave & Tun Thin, 1948. "Income Tax Progression, 1929-48," Journal of Political Economy, University of Chicago Press, vol. 56, pages 498-498.
    6. John Creedy & Norman Gemmell, 2004. "The Built-In Flexibility Of Income And Consumption Taxes In New Zealand," Australian Economic Papers, Wiley Blackwell, vol. 43(4), pages 459-474, December.
    7. Muellbauer, John, 1974. "Prices and Inequality: The United Kingdom Experience," Economic Journal, Royal Economic Society, vol. 84(333), pages 32-55, March.
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    More about this item

    Keywords

    tax progressivity; equivalent variations; budget shares;

    JEL classification:

    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H22 - Public Economics - - Taxation, Subsidies, and Revenue - - - Incidence
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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