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Optimal taxation and the tradeoff between efficiency and redistribution

Author

Listed:
  • George Economides

    (Athens University of Economics and Business)

  • Anastasios Rizos

Abstract

This paper studies the aggregate and distributional implications of introducing consumption taxes into an otherwise deterministic version of the standard neoclassical growth model with income taxes only and heterogeneity across agents. In particular, the economic agents differ among each other with respect to whether they are allowed to save (in physical capital) or not. Policy is optimally chosen by a benevolent Ramsey government. The main theoretical finding comes to confirm the widespread belief that the introduction of consumption taxes into a model with income taxes only, creates substantial efficiency gains for the economy as whole, but at the cost of higher income inequality. In other words, consumption taxes reduce the progressivity of the tax system, and maybe, from a normative point of view, this result justifies the design of a set of subsidies policies which will aim to outweigh the regressive effects of the otherwise more efficient consumption taxes.

Suggested Citation

  • George Economides & Anastasios Rizos, 2017. "Optimal taxation and the tradeoff between efficiency and redistribution," DEOS Working Papers 1701, Athens University of Economics and Business.
    • Handle: RePEc:aue:wpaper:1701
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    References listed on IDEAS

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    1. Lansing, Kevin J., 1999. "Optimal redistributive capital taxation in a neoclassical growth model," Journal of Public Economics, Elsevier, vol. 73(3), pages 423-453, September.
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    3. Laczó, Sarolta & Rossi, Raffaele, 2020. "Time-consistent consumption taxation," Journal of Monetary Economics, Elsevier, vol. 114(C), pages 194-220.
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    5. Krusell, Per, 2002. "Time-consistent redistribution," European Economic Review, Elsevier, vol. 46(4-5), pages 755-769, May.
    6. Diamond, Peter A & Mirrlees, James A, 1971. "Optimal Taxation and Public Production II: Tax Rules," American Economic Review, American Economic Association, vol. 61(3), pages 261-278, June.
    7. Diamond, Peter A & Mirrlees, James A, 1971. "Optimal Taxation and Public Production: I--Production Efficiency," American Economic Review, American Economic Association, vol. 61(1), pages 8-27, March.
    8. Konstantinos Angelopoulos & James Malley & Apostolis Philippopoulos, 2011. "Time-consistent fiscal policy under heterogeneity: Conflicting or common interests?," Working Papers 2011_06, Business School - Economics, University of Glasgow.
    9. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
    10. ColemanII, Wilbur John, 2000. "Welfare and optimum dynamic taxation of consumption and income," Journal of Public Economics, Elsevier, vol. 76(1), pages 1-39, April.
    11. Martin, Fernando M., 2010. "Markov-perfect capital and labor taxes," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 503-521, March.
    12. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, December.
    13. Isabel Correia, 2010. "Consumption Taxes and Redistribution," American Economic Review, American Economic Association, vol. 100(4), pages 1673-1694, September.
    14. Fischer, Stanley, 1980. "Dynamic inconsistency, cooperation and the benevolent dissembling government," Journal of Economic Dynamics and Control, Elsevier, vol. 2(1), pages 93-107, May.
    15. George Economides & Apostolis Philippopoulos, 2012. "Are User Fees Really Regressive?," CESifo Working Paper Series 3875, CESifo.
    16. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
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    Cited by:

    1. George Economides & Anastasios Rizos, 2021. "Optimal taxation: full-commitment versus time-consistent equilibrium," Economic Change and Restructuring, Springer, vol. 54(3), pages 717-753, August.

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    More about this item

    Keywords

    Ramsey taxation; heterogeneity; efficiency; inequality;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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