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Optimal tax mix in a two-sector growth model with transitional dynamics

  • James B. Davies

    (University of Western Ontario)

  • Jie Zhang

    (Victoria University of Wellington)

  • Jinli Zeng

    (National University of Singapore)

This paper examines the problem of optimal tax mix analytically in a two-sector growth model with transitional dynamics. Tax revenue is required to provide a pure public good. The key problems are: over-consumption of leisure under labor income or consumption taxes; and under-investments in human and physical capital under income taxes. Without investment subsidies, consumption taxes do better than uniform income taxes, but can be improved on locally via positive taxation of physical capital income and a negative tax on labor income. With subsidies the first best can be achieved in a system where: (i) if consumption and labor income taxes are non-zero they are of the same rate but opposite signs, (ii) the tax rate on physical capital income exceeds that on labor income, (iii) subsidy rates on investments equal income tax rates, for both forms of capital. In any given circumstances, a range of alternative tax mixes may provide equivalent results. This result, combined with practical constraints, may help to explain the variety of tax mixes observed across countries.

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File URL: http://www.fas.nus.edu.sg/ecs/pub/wp/wp0105.pdf
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Paper provided by National University of Singapore, Department of Economics in its series Departmental Working Papers with number wp0105.

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Length: 48 pages
Date of creation: Dec 2000
Date of revision:
Handle: RePEc:nus:nusewp:wp0105
Contact details of provider: Web page: http://www.fas.nus.edu.sg/ecs/index.html

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