A computational model of optimal commodity taxation
This report examines the structure of optimal commodity tax rates in a many-person many-goods static computational model using segmented LES utility. One of the major findings is that with non-linear Engel curves and linear income tax, optimal commodity tax rates tend to be progressive and highly dispersed under logarithmic utility specifications. However, the dispersion of tax rates is considerably reduced if the inequality aversion of society is low or if tax evasion depends among other things on disparities between commodity tax rates. With exogenously given non-optimal and non-linear income tax schedules, usually there is still a need for differentiated and progressive commodity taxation. Tax evasion tends to reduce optimal tax rates for necessities but increases them for luxuries. Private compliance costs and government administration costs reduce optimal tax rates by a similar amount to the share of these costs from taxes. The results indicate that in a redistributive model the effect of externalities on optimal tax rates exceeds the corresponding Pigovian tax rates or subsidies. The main benefit of higher taxes on leisure complements than leisure substitutes appears to relate to increased tax revenue for redistribution rather than improvement in the utility position of those paying the taxes. The effect of complexities such as tax evasion, administrative costs, externalities and leisure complements/substitutes on redistribution is not neutral. Generally, these complexities tend to increase the progressivity of optimal commodity tax rates. Explanations are provided why the numerical results presented here do not contradict the Laroque-Kaplow proposition, which advocates uniform commodity taxation. Some practical application problems and logical weaknesses of the Laroque-Kaplow proposition are noted.
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