Comparing the welfare effects of income and excise taxes in the presence of the other taxation paradox

This paper implements numerically a general equilibrium model in which all private producers are price makers and the government utilizes tax revenues to provide a public good. After deriving the partial equilibrium condition for an excise tax to increase price by more than the tax (for a monopoly firm), numerical examples are given, demonstrating this phenomenon for both partial and general equilibrium. In the general equilibrium context, optimal excise taxation and optimal flat-rate income taxation are compared. In the excise tax regime, prices increase by more than the taxes. In the income tax regime, prices actually decline relative to the no-tax regime. In all of the examples given, flat-rate income taxation is superior to excise taxation in terms of welfare. The author has benefitted from exceptionally helpful comments received from J. Ronnie Davis, John D. Wilson, Ralph W. Pfouts, and Amy Crews. He has also benefitted from conversations with Franz Gehrels, David E. Wildasin, Herbert J. Kiesling, and Harold York. The usual disclaimer applies.