Inverse Elasticity Rule in a Production Efficiency Problem
Diamond and Mirrlees (1971) and Dasgupta and Stiglitz (1972) show that production efficiency is achieved under the optimal commodity tax when profit income is zero. Here, we consider the simplest possible model to analyze production efficiency in the presence of profit income: a tax reform problem in an economy with a representative consumer, two goods, and two firms with decreasing returns to scale technologies. We show that differentiating a uniform producer tax according to the inverse elasticity rule, while keeping government revenue constant, reduces additional distortions caused by the presence of profit income and improves social welfare.
|Date of creation:||30 Jun 2011|
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- Hatta, Tatsuo, 1986. "Welfare effects of changing commodity tax rates toward uniformity," Journal of Public Economics, Elsevier, vol. 29(1), pages 99-112, February.
- Dasgupta, Partha & Stiglitz, Joseph E, 1972. "On Optimal Taxation and Public Production," Review of Economic Studies, Wiley Blackwell, vol. 39(1), pages 87-103, January.
- 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 261-78, June.
- 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.
- Mirrlees, James A, 1972. "On Producer Taxation," Review of Economic Studies, Wiley Blackwell, vol. 39(1), pages 105-11, January.
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