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Welfare Effects of Tax and Price Changes and the CES-UT Utility Function

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  • Knud Jørgen Munk

    () (School of Economics and Management, University of Aarhus, Denmark)

Abstract

Dixit’s 1975 paper "Welfare Effects of Tax and Price Changes" constitutes a seminal contribution to the theory of tax reform within a second-best general equilibrium framework. The present paper clarifies ambiguities with respect to normalisation which has led to misinterpretation of some of Dixit’s analytical results. It proves that a marginal tax reform starting from a proportional tax system will improve social welfare if it increases the supply of labour, whatever the rule of normalisation adopted. In models which impose additive separability between consumption and leisure in household preferences this insight cannot be articulated. This paper proposes as an alternative a parameterised utility function with explicit representation of the use of time, the CES-UT, which allows a flexible representation of the relationship between consumption and leisure. It also demonstrates how standard compensated price elasticities can be derived from the parameters of the CES-UT and how it may be used for applied tax reform analysis.

Suggested Citation

  • Knud Jørgen Munk, 2006. "Welfare Effects of Tax and Price Changes and the CES-UT Utility Function," Economics Working Papers 2006-15, Department of Economics and Business Economics, Aarhus University.
  • Handle: RePEc:aah:aarhec:2006-15
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    File URL: ftp://ftp.econ.au.dk/afn/wp/06/wp06_15.pdf
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    Cited by:

    1. repec:wsi:ijitdm:v:11:y:2012:i:03:n:s0219622012500150 is not listed on IDEAS
    2. Knud Munk, 2008. "Tax-tariff reform with costs of tax administration," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 15(6), pages 647-667, December.

    More about this item

    Keywords

    Public economics; optimal taxation; tax reform; tax simulation; CGE models;

    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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