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Inverse Elasticity Rule in a Production Efficiency Problem

Author

Listed:
  • Anthony Hannagan

    (Boston College)

  • Hideo Konishi

    (Boston College)

Abstract

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.

Suggested Citation

  • Anthony Hannagan & Hideo Konishi, 2011. "Inverse Elasticity Rule in a Production Efficiency Problem," Boston College Working Papers in Economics 778, Boston College Department of Economics.
    • Handle: RePEc:boc:bocoec:778
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    References listed on IDEAS

    as
    1. W. J. Corlett & D. C. Hague, 1953. "Complementarity and the Excess Burden of Taxation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 21(1), pages 21-30.
    2. Partha Dasgupta & Joseph Stiglitz, 1972. "On Optimal Taxation and Public Production," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 39(1), pages 87-103.
    3. R. G. Lipsey & Kelvin Lancaster, 1956. "The General Theory of Second Best," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 24(1), pages 11-32.
    4. 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.
    5. J. A. Mirrlees, 1972. "On Producer Taxation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 39(1), pages 105-111.
    6. 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.
    7. Myles,Gareth D., 1995. "Public Economics," Cambridge Books, Cambridge University Press, number 9780521497695.
    8. Hatta, Tatsuo, 1986. "Welfare effects of changing commodity tax rates toward uniformity," Journal of Public Economics, Elsevier, vol. 29(1), pages 99-112, February.
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    More about this item

    Keywords

    production efficiency; inverse elasticity; profit income;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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