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A Simple Model of Optimal Tax Systems: Taxation, Measurement and Uncertainty

  • Sanjit Dhami

    ()

  • Ali al-Nowaihi

    ()

The neglect of administrative issues is a serious limitation of optimal tax theory, with implications for its practical applicability. Under uncertainty, the problems for optimal tax theory are compounded when the full set of tax instruments is neglected. These twin issues are addressed in this paper, by focussing on a fundamental implication of administrative problems, namely, that the tax bases are measured with some error. Consumption taxes can perform the ‘social insurance role of taxation’; a role previously ascribed only to income taxes. A combination of income and consumption taxes can hedge income and measurement-error risks better, relative to the imposition of these taxes alone. The optimal taxes are decreasing in the imprecision with which the corresponding tax base is measured. The taxpayer engages in precautionary savings, in response to uncertainty arising on account of income and measurement problems. Differential commodity taxes, tailored to the measurability characteristics of the different tax bases, dominate uniform commodity taxes. Furthermore, the paper provides a simple, tractable framework for optimal tax theorists interested in diverse kinds of uncertain situations.

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File URL: http://www.le.ac.uk/economics/research/RePEc/lec/leecon/dp05-25.pdf
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Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 05/25.

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Date of creation: Aug 2005
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Handle: RePEc:lec:leecon:05/25
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  1. repec:cup:cbooks:9780521497695 is not listed on IDEAS
  2. Strawczynski, Michel, 1998. "Social insurance and the optimum piecewise linear income tax," Journal of Public Economics, Elsevier, vol. 69(3), pages 371-388, September.
  3. Chris Heady, 1993. "Optimal taxation as a guide to tax policy: a survey," Fiscal Studies, Institute for Fiscal Studies, vol. 14(1), pages 15-41, February.
  4. Burgess, Robin & Stern, Nicholas, 1993. "Taxation and Development," Journal of Economic Literature, American Economic Association, vol. 31(2), pages 762-830, June.
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