Uncertainty, Commitment, and Optimal Taxation

This paper examines the optimal tax design problem in the presence of wage uncertainty. The wage has a continuous distribution, individuals are ex ante identical, preferences are separable in labor supply and goods, public policy aims at providing the population with social insurance, and the only restriction on the tax instruments is that emanating from lack of public observability of realized wages and labor supplies. We show that optimal tax structures depend crucially on whether it is labor supply or goods that consumers have to commit to before the resolution of uncertainty. Specifically, we prove that, in the absence of commitment, the social insurance problem collapses to the traditional optimal tax problem. Second, if labor supply is precommitted, it would be possible to effect a first-best outcome. Third, commitment to goods would make indirect taxation a useful instrument of tax policy even in the presence of a general income tax; it requires differential tax treatment of committed and noncommitted goods. Finally, if preferences are separable between the two types of goods, precommitted goods must be taxed at a uniform rate lower than that on the noncommitted goods.     

Intergenerational Allocation of Government Expenditures: Externalities and Optimal Taxation

This paper studies optimal capital and labor income taxes when the benefits of public goods are age‐dependent. Provided the government can impose a consumption tax, it can attain the first‐best resource allocation. This involves the uniform taxation of the cohorts' labor income and a zero capital income tax. With no consumption tax and optimally chosen government spending, labor income should be taxed nonuniformly across cohorts and the capital income tax should be nonzero. Deviations of the public goods from their respective optima create distortions. These affect the labor supply decisions of both cohorts and capital accumulation, providing a further reason to tax (or subsidize) capital income.     

Externalities and optimal taxation

This paper reexamines the optimal tax design problem (income and commodities) in the presence of externalities. The nature of the second–best, and the choice of the tax instruments, are motivated by the informational structure in the economy. The main results are: (i) environmental levies (linear or nonlinear) differ in formula from Pigouvian taxes by the expressions for the optimal tax on private goods; (ii) externalities do not affect commodity tax formulas (linear and nonlinear) for private goods; (iii) externalities do not affect the income tax structure if commodity taxes are nonlinear and affect it if commodity taxes are linear; and (iv) a general income tax plus strictly Pigouvian taxes are sufficient for efficient taxation if individuals of different types have identical marginal rates of substitution (at any given consumption bundle).     

Environmental taxes with heterogeneous consumers: an application to energy consumption in France

This paper constructs a model with four groups of households who have preferences over labor supply, consumption of polluting (energy related) and non-polluting (non-energy) goods, and emissions. It quantifies the model for the French economy and computes its optimal tax equilibria under nine second-best tax regimes. We find that the redistributive role of environmental taxes requires the polluting goods to be taxed at a rate much below their marginal social damage. These goods may even require an outright subsidy if the society values equality ‘a lot’. Secondly, if environmental taxes that have an exclusively externality-correcting role, they benefit all types—although the gains are rather modest. The gains and losses become more substantial when environmental taxes have a redistributive role as well. Third, setting the environmental tax at its Pigouvian level, rather than its optimal externality-correcting-cum-redistributive level, benefits the high-income group at the expense of the low-income groups. Fourth, nonlinear taxation of polluting goods, and nonlinear commodity taxation in general, is a powerful redistributive mechanism. Fifth, introducing environmental taxes in the current French tax system, with its suboptimal income taxes, results in substantial welfare gains for the highest income group and a sizable loss for the least well-off persons.     

Production Efficiency and the Direct-Indirect Tax Mix

In the design of the optimal direct/indirect tax mix, the canonical view was laid by Atkinson and Stiglitz (1976) who showed that commodity taxes are unnecessary in an economy in which there is an optimal nonlinear income tax provided that commodities are separable from labor in the utility functions of all taxpayers, that the aggregators over these commodities are ordinally equivalent and that wages are fixed. When wages are endogenous, Naito (1999) showed that this result may not hold and in addition that production efficiency may not be Pareto optimal. Given an optimal nonlinear income tax, we show that production inefficiency is Pareto optimal if the aggregate technology set is strictly concave. The Atkinson–Stiglitz condition is neither necessary nor sufficient for zero commodity taxation and commodity taxes are part of almost all Pareto optima.     

Poverty alleviation and tax policy

This paper examines public good provision and tax policy—optimal non-linear income taxation and linear commodity taxation—when the government departs from purely welfarist objective function and seeks to minimise poverty. This assumption reflects much policy discussion and may help understand some divergences of practical tax policy from lessons in optimal tax analysis. In contrast to Atkinson and Stiglitz (J. Public Econom. 6 (1976) 55), it may be optimal to use differentiated commodity tax rates, including the taxation of savings, even if preferences are separable in goods and leisure. The optimal effective marginal tax rate at the bottom of the distribution may be negative, suggesting that wage subsidy schemes can be optimal. Finally, optimal provision of a public good is analysed under poverty minimisation.     

On Optimal Commodity Taxes When Consumption Is Time Consuming

This paper studies the problem of optimal taxation of commodities when consumption is a time‐consuming activity. This is done under two distinct preference separability assumptions: between goods and labor supply, and between goods and leisure. It argues that with the labor separability, the traditional uniform taxation results of optimal tax theory continue to hold. With leisure separability, on the other hand, consumption time is a major ingredient of optimal tax rates. However, the relationship between consumption time and optimal tax rates depends crucially on the representation of the economy. In representative consumer economies, time differences determine the pattern of optimal tax rates so that goods whose consumption take more time are subjected to higher tax rates. When individuals have different earning abilities, redistributive, incentive, and efficiency considerations also come into play resulting in a complex relationship. The paper derives formulas for optimal commodity taxes in this case on the basis of three different tax structures: linear commodity taxes in combination with linear and nonlinear income taxes, and nonlinear commodity taxes in combination with nonlinear income taxes.     

Budget Balancedness and Optimal Income Taxation

We make two contributions to the theory of optimal income taxation. First, assuming conditions sufficient for existence of a Pareto optimal income tax and public goods mechanism, we show that if agents' preferences satisfy an extended notion of single crossing called capacity constrained single crossing, then there exists a Pareto optimal income tax and public goods mechanism that is budget balancing. Second, we show that, even without capacity constrained single crossing, existence of a budget balancing Pareto optimal income tax and public goods mechanism is guaranteed if the set of agent types contains no atoms.     

Taxation of capital income in overlapping generations economies

Whether capital income should be taxed in overlapping generations economies is vividly discussed. It is shown that intergenerational lump‐sum taxes cannot implement the Golden Rule allocation when agents have private information on their earnings potential. Hence, the seminal Atkinson–Stiglitz result that optimal income taxation pre‐empts any role for indirect taxation cannot be interpreted to imply that capital income taxation (affecting intertemporal relative prices) should not be taxed. Specifically, capital income should unambiguously be taxed in small open economies, and the optimal tax rate depends inversely on the elasticity of total savings to disposable income and the after‐tax rate of return.     

Optimal climate and fiscal policy in an OLG economy

This paper develops a climate–economy model to study the joint design of optimal climate and fiscal policies in economies with overlapping generations (OLGs). I demonstrate how capital taxation, if optimal, drives a wedge between the market costs of carbon (the net present value of marginal damages using the market interest rate) and the Pigouvian tax (the net present value of marginal damages using the consumption discount rate of successive OLGs). In contrast to deterministic infinitely lived representative agent models, at the optimum, the capital income tax is positive, the carbon price equals the market costs of carbon but it falls short of the Pigouvian tax when (i) preferences are not separable over consumption and leisure; and (ii) labor income taxes cannot be age-dependent. I also show that restrictions on climate change policy provide a novel rationale for positive capital income taxes.     

Taxation without commitment

This paper considers a Ramsey model of linear capital and labor income taxation in which a benevolent government cannot commit ex-ante to a sequence of policies for the future. In this setup, if the government is forced to keep budget balance in every period, then it may not be able to sustain zero capital taxes in the long run, as shown in Benhabib and Rustichini (J Econ Theory 77:231–259, 1997) and Phelan and Stachetti (Econometrica 69:1491–1518, 2001). However, (Dominguez in J Econ Theory 135:159–170, 2007) shows that if the government is allowed to borrow and lend to households, the optimal capital income tax still converges to zero in the long run, as long as the value of defaulting is independent of the level of government debt. This paper provides a game theoretic setup with government debt where the value of the worst equilibrium only depends on the initial level of capital and can be determined in advance. This implies that under our assumptions the best sustainable equilibrium has zero capital taxes in the long run, even in the absence of government commitment.     

Efficient decentralized fiscal and environmental policy: A dual purpose Henry George tax

One consequence of decentralized responsibility to set tax policy and environmental standards is that local governments might try to attract industry and jobs by underproviding local public goods with lower taxes or lax environmental standards or both. But if local authorities exploit fixed property site (i.e., land) taxation to fund local public goods, affect firm migration, and internalize potential local emission rents, herein we find decentralized efficiency is supported. This result reflects a dual form of the classic Henry George theorem previously overlooked.     

Taxation and the sustainability of collusion: ad valorem versus specific taxes

Assuming constant marginal cost, it is shown that a switch from specific to ad valorem taxation that results in the same collusive price has no effect on the critical discount factor required to sustain collusion. This result is shown to hold for Cournot oligopoly when collusion is sustained with Nash-reversion strategies or optimal-punishment strategies. In a Cournot duopoly model with linear demand and quadratic costs, it is shown that the critical discount factor is lower with an ad valorem tax than with a specific tax that results in the same collusive price. However, in contrast to Colombo and Labrecciosa (J Public Econ 97:196–205, 2013) it is shown that the revenue is always higher with an ad valorem tax than with a specific tax.     

A pigovian rule for the optimum provision of public goods

The integrated treatment of optimal taxation and public expenditure presented here is based on the dual relationship between the prices of private goods and the quantities of public goods. The conditions for optimum public good provision can be expressed as a modification of the Samuelson conditions with extra terms representing (a) the distortionary effect of taxes on the willingness to pay for the public good, and (b) distributional effects. The former captures Pigou's notion of the indirect damage caused by the need to finance public expenditure out of distortionary taxes, and we call this the ‘Pigou term’. In certain cases a very simple benefit-cost ratio for public projects emerges that is equivalent to measuring benefits as if they were taxed.     

The weight of the median voter ageing on public debt

This paper studies the relationship between an ageing society and voter preference for financing public expenditures with debt versus income taxation. We focus on advanced economies and OECD members where ageing is relatively severe, the political process is more democratic, and economic institutions are subject to electorate scrutiny. Since there are no international data sources available for the median voter age, one of the contributions of this paper is the construction of a median voter series for the countries included in the study. The sample period covers 30 years, from 1980 to 2010. The panel estimates confirm the Brennan hypothesis (Const Polit Econ 23(3):182–198, 2012). A 1-year ageing of the median voter increases the public debt to GDP ratio by on the order of 4.5 percentage points.     

Should mobile capital pay for public infrastructure investment?

The paper contributes to the discussion of fiscal competition with infrastructure goods. We explicitly focus on the costs of providing public infrastructure capital that appear in the public budget as investment. Thus we analyse the problem in a dynamic framework. Public infrastructure is considered as a marginal product complement to private capital. A central result of the model is that the fact that public capital is a complement to private capital, so that an increase in the supply of public capital ceteris paribus improves the marginal productivity of private capital, cannot be used as an argument to support a source tax. The so-called indirect productivity effect on private capital induced by public inputs does not justify the taxation of mobile capital. Rather, the efficiency of a source tax on mobile capital income depends on the question of whether or not the public input generates a factor rent to private capital.

Optimum income taxation and layoff taxes

This paper analyzes optimum income taxation in a model with endogenous job destruction that gives rise to unemployment. It is shown that optimal tax schemes comprise both payroll and layoff taxes when the state provides public unemployment insurance and aims at redistributing income. The optimal layoff tax is equal to the social cost of job destruction, which amounts to the sum of unemployment benefits (that the state pays to unemployed workers) and payroll taxes (that the state does not get when workers are unemployed).     

On the undesirability of commodity taxation even when income taxation is not optimal

An important result due to Atkinson and Stiglitz (1976) [Atkinson, A.B., Stiglitz, J.E., 1976. The design of tax structure: Direct versus indirect taxation. Journal of Public Economics 6, 55–75.] is that differential commodity taxation is not optimal in the presence of an optimal nonlinear income tax (given weak separability of utility between labor and all consumption goods). This article demonstrates that this conclusion holds regardless of whether the income tax is optimal. In particular, given any commodity tax and income tax system, differential commodity taxation can be eliminated in a manner that results in a Pareto improvement. Also, differential commodity taxation can be proportionally reduced so as to generate a Pareto improvement. In addition, for commodity tax reforms that neither eliminate nor proportionally reduce differential taxation, a simple efficiency condition is offered for determining whether a Pareto improvement is possible.     

Direct Versus Indirect Taxation: The Design of the Tax Structure Revisited

This article studies the optimal direct/indirect tax mix problem when individuals differ in several unobservable characteristics (productivity and endowments). It presents general expressions for the optimal commodity tax rates and proves that contrary to Atkinson and Stiglitz's (1976) result, differential commodity taxation remains a useful instrument of tax policy even if preferences are separable between labor and produced goods. When cross substitution effects are zero, the expressions resemble traditional many households Ramsey rules. In a Cobb–Douglas illustration, where endowments differ only in good 1 (interpreted as “wealth”), the tax on good 2 provides an indirect way to tax the unobservable wealth.