The Economics of Taxation

The Economics of Taxation

Bernard Salanié
Copyright Date: 2011
Published by: MIT Press
Pages: 248
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  • Book Info
    The Economics of Taxation
    Book Description:

    This concise introduction to the economic theories of taxation is intuitive yet rigorous, relating the theories both to existing tax systems and to key empirical studies. The Economics of Taxation offers a thorough discussion of the consequences of taxes on economic decisions and equilibrium outcomes, as well as useful insights into how policy makers should design taxes. It covers such issues of central policy importance as taxation of income from capital, environmental taxation, and tax credits for low-income families. This second edition has been significantly revised and updated. Changes include a substantially rewritten chapter on direct taxation; a discussion of recent research in the chapter on mixed taxation; the replacement of the chapter on capital taxation with a chapter on the "new dynamic public finance"; and considerations of environmental taxation in both theory and policy chapters. The book is aimed at graduate students or advanced undergraduates taking public finance classes as well as economists who want to learn more about the topic. It combines discussion of theory, empirical work, and policy objectives in compact form. Appendixes provide necessary background material on consumer and producer theory and the theory of optimal control.

    eISBN: 978-0-262-29869-8
    Subjects: Finance, Business

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-viii)
  3. Foreword
    (pp. ix-x)

    This book originated in a course taught at Ensae (Paris) and at the University of Chicago; this resulted in myThéorie économique de la fiscalité, published by Economica in Paris. The MIT Press editions are revised and expanded versions of the French version. I greatly benefited from the reactions of the students who went through my courses, as well as from anonymous reviews. I thank, without implicating Arnaud Buissé, Dominique Bureau, Paul Champsaur, Pierre-André Chiappori, Christian Gouriéroux, Anne Laferrère, Guy Laroque, Thomas Piketty, Jean-Charles Rochet, François Salanié, Jean-Luc Schneider, Alain Trannoy, and especially Philippe Choné for their comments on a...

  4. Introduction
    (pp. 1-12)

    The word “taxation” can take different meanings. In a strict sense, taxation is the set of taxes that economic agents pay. In the larger sense, it pertains to the whole fiscal policy of governments. I will use it in an intermediate sense. In this book, taxation refers both to taxes and to transfers to households. These transfers are usually classified in two categories:

    social insurance, which is linked to contributions (depending on countries: pensions, health, family, and/or unemployment benefits)

    social welfare, which pays benefits that do not depend on earlier contributions (e.g., minimum income benefits or housing subsidies).

    This distinction...

  5. I The Effects of Taxation
    • 1 Distortions and Welfare Losses
      (pp. 15-40)

      A traditional technocratic view of the economist is that his role is to take governmental objectives and find a way to implement them that minimizes distortions or, equivalently, that reduces the efficiency of the economy by as little as possible. But what are these distortions, and how can they be measured? At a Pareto optimum the marginal rates of substitution of all consumers are equal to the technical marginal rates of substitution of all firms. Under the usual conditions and without taxation, the competitive equilibrium is Pareto optimal because every consumer equates his marginal rates of substitution to the relative...

    • 2 Tax Incidence
      (pp. 41-62)

      Who pays taxes? An immediate answer would suggest that it is the person who signs the check.¹ So, if we accept this answer, it must be that in the many countries where the income tax is paid as is it is earned (where the employer sends a check to the tax authorities), firms pay the personal income tax; this clearly is absurd. Suppose in this example that the income tax increases; then firms may try to maintain constant labor costs by reducing net wages dollar for dollar. As a result some workers will withdraw from the labor market. To keep...

  6. II Optimal Taxation
    • [II Introduction]
      (pp. 63-66)

      This second part is dedicated to the study of optimal taxation. This is a very old topic. Smith (Wealth of Nations, V.ii.b) listed four criteria for good taxes:

      1. Each taxpayer must pay an equitable share related to his ability to pay and/or to the benefits he gets from the state. (Today we would distinguish horizontal equity and vertical equity. Horizontal equity requires that any two “identical” persons must be treated “identically”—which clearly leaves some room to interpretation. Vertical equity requires that some taxpayers, because for instance of a higher ability to pay, must pay more than others.)


    • 3 Indirect Taxation
      (pp. 67-82)

      We assume in this chapter that the government cannot use a nonlinear tax on income. The only available tax instruments are linear, possibly differentiated taxes on goods and a linear tax on wages. This approach may seem unduly restrictive, but it played a very important role in the development of theory.

      The first analysis of this problem is due to Ramsey (1927); his results were rediscovered several times, by Hotelling (1932, sec.7) and later by Samuelson in a note to the US Secretary of the Treasury (1951, published in 1986). Diamond–Mirrlees (1971b) extended Ramsey’s results to an economy with...

    • 4 Direct Taxation
      (pp. 83-122)

      Chapter 3 characterized optimal indirect taxation when the tax on wages is proportional. In practice, most developed countries use a graduated income tax. Even when a “flat tax” with a single tax rate is proposed (as in the United States), it usually includes a personal exemption so that the tax is progressive.¹ The shape of the income tax schedule is a key issue of the democratic debate. The personal income tax is not the only tax that depends on income. Thus in this chapter we define direct taxation as comprising all taxation that depends on primary income, which includes payroll...

    • 5 Mixed Taxation
      (pp. 123-132)

      We characterized optimal indirect taxation in chapter 3 when the tax on wages is proportional. We saw there that in the simplest case (a representative consumer, zero cross-elasticities of demand), the tax rates on the various goods are inversely proportional to the compensated elasticities of their demand functions. In this chapter we see that with an optimal direct tax (which in general is nonlinear), this result breaks down completely: in this and some other cases, indirect taxation in effect becomes superfluous.

      This result is known as the Atkinson–Stiglitz Irrelevance Theorem. This theorem goes against the grain of traditional analyses,...

    • 6 Risk and Time
      (pp. 133-152)

      Our discussion of optimal direct taxation in chapter 4 focused on a one-period model. This is clearly restrictive: taxation of labor income in any given year can affect savings, which in turn changes labor supply in years to come. When deciding how best to trade off equity and efficiency, the government must take into account these intertemporal responses. In chapter 4 we also assumed, for the most part, that taxpayers face no uncertainty when choosing how much to work; yet we saw briefly in section 4.3.3 that if faxpayers do face uncertainty, the tax system can be used to provide...

    • 7 Corrective Taxes
      (pp. 153-164)

      Up to this chapter we have focused on situations where in the absence of taxes, the economy is efficient. In such economies, taxation is a necessary evil: it must be used to finance the government’s activities, to provide public goods, or to redistribute income, but because the theoretical ideal (lump-sum transfers) is impractical, taxation moves the economy away from the first best.

      As has been clear for a long time, real-world economies suffer from a variety of market failures, among which imperfect competition, external effects, incomplete markets, and asymmetric information stand out.¹ It is no less clear that economists and...

    • 8 Criticisms of Optimal Taxation
      (pp. 165-178)

      We devoted four chapters to optimal taxation. Some economists would think that this is too much, for reasons that we will briefly discuss in this chapter.

      A first category of criticisms comes from within the theory itself. Even if we accept the viewpoint of optimal taxation, we may find some of its assumptions debatable. We already discussed many such objections, and we will focus here on two categories of criticisms that are more external to the theory of optimal taxation: the representation of social preferences, and the practical aspects of putting tax theory to work.

      Is it realistic to attribute...

  7. III Some Current Debates
    • 9 Low-Income Support
      (pp. 181-202)

      Even in a perfectly competitive economy, without any governmental intervention or any other distortion, the free play of the market may leave some agents with low income. Some low productivity individuals are only offered low wages; some whose disutility of labor is relatively large to their offered wage may refuse to work. Thus in an idealized economy, there may be two groups of poor: the working poor and the nonemployed poor. Of course, the distortions in real-world economies affect the sizes of these two groups. For instance, monopsony power by employers can push wages down and some workers into poverty....

    • 10 Taxation and Global Warming
      (pp. 203-218)

      Environmental taxation has grown markedly over the past twenty years; it now brings about 6 percent of tax revenues in the OECD.¹ Until the end of the 1990s most of these taxes were raised on fuels, and concerns for the environment were often not their main motivation; the negative congestion externalities of automobiles also figured prominently.² Many of the more recent taxes were expressly to mitigate global warming.

      According to the most recent report of the International Panel on Climate Change (IPCC 2007), “most of the observed increase in global average temperatures since the mid-20th century is very likely due...

  8. IV Appendixes
  9. Index
    (pp. 233-238)