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The Theory of Taxation and Public Economics

The Theory of Taxation and Public Economics

Copyright Date: 2008
Edition: STU - Student edition
Pages: 496
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  • Book Info
    The Theory of Taxation and Public Economics
    Book Description:

    The Theory of Taxation and Public Economicspresents a unified conceptual framework for analyzing taxation--the first to be systematically developed in several decades. An original treatment of the subject rather than a textbook synthesis, the book contains new analysis that generates novel results, including some that overturn long-standing conventional wisdom. This fresh approach should change thinking, research, and teaching for decades to come.

    Building on the work of James Mirrlees, Anthony Atkinson and Joseph Stiglitz, and subsequent researchers, and in the spirit of classics by A. C. Pigou, William Vickrey, and Richard Musgrave, this book steps back from particular lines of inquiry to consider the field as a whole, including the relationships among different fiscal instruments. Louis Kaplow puts forward a framework that makes it possible to rigorously examine both distributive and distortionary effects of particular policies despite their complex interactions with others. To do so, various reforms--ranging from commodity or estate and gift taxation to regulation and public goods provision--are combined with a distributively offsetting adjustment to the income tax. The resulting distribution-neutral reform package holds much constant while leaving in play the distinctive effects of the policy instrument under consideration. By applying this common methodology to disparate subjects,The Theory of Taxation and Public Economicsproduces significant cross-fertilization and yields solutions to previously intractable problems.

    eISBN: 978-1-4008-3922-3
    Subjects: Finance, Economics, Business

Table of Contents

  1. (pp. 1-10)

    This book develops and applies a unifying framework for the analysis of taxation and related subjects in public economics. Its two central features are explicit attention to the social objective of welfare maximization and direct examination of how various government instruments should be orchestrated to achieve that objective. Consistent application of this approach solidifies and extends some familiar results and intuitions, overcomes seemingly intractable obstacles regarding other issues, and overturns several important settled understandings.

    Mirrlees (1971), although most remembered for pathbreaking technical analysis of optimal nonlinear income taxation, also provides the seminal modern articulation of this research agenda. Concerns about...


    • (pp. 13-34)

      Ideally, policy analysis attempts to consider completely specified policies, take a comprehensive view of the problem at hand with regard to potentially useful instruments, and present and assess alternatives in a comparable manner. These features are particularly important in developing a theory of taxation and in examining related subjects in public economics.

      Completeness means that a policy must be fully articulated in all pertinent respects. An important requirement in the present setting is budget balance.¹ In spite of its familiarity, its dictates are sometimes forgotten, which can lead analysis astray—for example, by omitting income and substitution effects of expenditures...

    • (pp. 35-50)

      Optimal income tax analysis employs the standard welfare economic approach to policy assessment. Because much analysis of tax policy and related subjects in public economics does not employ this method, this chapter begins by explaining the need for explicit attention to the social objective function. Many of the policies to be examined pose tradeoffs, not only in choosing the overall extent of redistribution but also in making many specific design decisions, and coherent formulation of these tradeoffs is often impossible without direct reference to the social objective. Such explicitness is also helpful in articulating research agendas because it is necessary...


    • (pp. 53-79)

      This chapter begins with a description of the optimal income taxation problem as generally formulated in the literature and then presents the main results and simulations both for the special cases of a linear income tax and a two-bracket income tax and for the general case of a nonlinear income tax. As is conventional, the model considered will involve a one-period setting in which individuals’ only choice variable is their degree of labor effort, there is a single composite consumption good, and government expenditures on public goods are taken as given. Much of the remainder of this book considers how...

    • (pp. 80-121)

      The classical analysis of the optimal labor income taxation problem presented in chapter 4 suggests the importance of further exploring the elasticity of labor supply. Additionally, that analysis is subject to numerous qualifications regarding matters of administration, the relationship between income and underlying earning ability, the nature of individuals’ preferences, various market imperfections, general equilibrium considerations, and other factors. This chapter briefly considers these issues. Many of the questions addressed here have received limited attention despite their potential significance, and some topics that have benefited from greater scrutiny nevertheless remain unresolved.

      Empirical work on the incentive effects of labor income...

    • (pp. 122-148)

      Much government activity, even aside from pure labor income taxation and income transfer programs, is motivated by or has the effect of redistributing income. This obviously includes other forms of taxation—such as the taxation of various commodities and exemptions from broad consumption taxes (like a VAT) for food or other necessities, corporate and other capital taxation, wealth and transfer (estate-gift) taxation, and the social security tax and transfer system. Redistribution also occurs as a consequence of expenditures on public goods and all manner of regulation, whether of externalities, workplace safety, or international trade.

      This chapter will focus on one...


    • (pp. 151-178)

      The optimal income tax problem examined in chapter 4 involves selecting a tax and transfer schedule,T(wl), to maximize social welfare. This chapter considers important features of many transfer programs. However, since transfers are already part of the scheduleT(wl) and since the domain of the schedule covers all income levels, including the lowest, one might wonder why additional attention is required. The main justifications are the existence of programs targeted at the poor, the possibility that special characteristics of the low-income population may require a qualitatively different approach, and the fact that under various social welfare functions and plausible...

    • (pp. 179-218)

      Government expenditures on goods and services constitute a substantial fraction of GDP in most countries.¹ Accordingly, their distributive incidence is presumptively important, especially since it cannot be assumed that the benefits of such government provision are distributed proportionately to private goods consumption. In particular, publically provided goods and services may contribute heavily to the standard of living of the poor, especially in countries with a large public sector. Thus, there is reason to believe that the omission of goods and services from analysis pertaining to redistribution would provide an incomplete and potentially misleading understanding of the subject.

      More specifically, as...


    • (pp. 221-248)

      The analysis of optimal income taxation in chapter 4, following convention, is conducted in a one-period setting in which individuals choose only labor effort; hence, the income tax under discussion is a labor income tax. The model in chapter 6 extends the analysis to consider the case in which individuals also allocate disposable income among different consumption goods. Following the approach of Atkinson and Stiglitz (1976, 1980) and others, this chapter adapts the same model to examine the taxation of capital income (the return to savings). This application is accomplished simply by viewing consumption in different time periods as an...

    • (pp. 249-274)

      Private voluntary transfers, from one individual to another, may be subject to taxation under an income or consumption tax as well as under a tax regime aimed specifically at transfers. A typical income tax provides no deduction for donors’ gifts, implicitly treating them as a form of consumption by donors, but excludes gift receipts from donees’ tax base, which, as Simons (1938) argued, conflicts with the notion of comprehensively taxing “income.” Under a cash-flow consumption tax, gifts could be deemed consumption of donors, donees, or both; the last option is not ordinarily proposed but nevertheless seems most consistent with the...

    • (pp. 275-314)

      A substantial fraction of taxation and expenditure in developed economies is devoted to social insurance, especially to finance consumption during years of retirement (including consumption of medical care). Systems typically impose a labor income tax—such as a flat-rate payroll tax—during working years to finance payments to retirees.¹

      This chapter first analyzes purely redistributive aspects of social security schemes in a setting in which individuals are taken to be rational, far-sighted utility maximizers not subject to liquidity constraints. Then these assumptions are relaxed for purposes of considering a central feature of social security, the forcing of a minimum level...

    • (pp. 315-344)

      Tax schedules and transfer programs can and often do depend on family structure, notably, on whether there are one or two adults and on the number of children. How taxes and transfers should depend on such family characteristics has proved controversial, and the treatment of different family types exhibits substantial variation among programs, across countries, and over time.¹

      This chapter analyzes taxation of families as an extension of the optimal income taxation framework. It begins by considering a simplified setting in which only distribution across families is at issue, thereby abstracting from labor effort and the endogeneity of family structure....


    • (pp. 347-369)

      In the standard welfare economic framework sketched in chapter 3 and used thereafter, policies are assessed by reference to a social welfare function (SWF) that aggregates the effects of policies on each individual’s well-being (utility). Chapter 14 will consider the process of aggregation itself. The present chapter focuses on what social welfare is taken to be a function of. Considered first is the doctrine referred to as welfarism, under which social welfare is taken to depend on individuals’ levels of well-being and on nothing else. Then attention shifts to the meaning of the concept of well-being and an examination of...

    • (pp. 370-390)

      Chapter 13 presents the rationale for the SWF to be a function of individuals’ utilities (and of nothing else). This chapter considers two remaining questions. First, how should individuals’ utilities be aggregated? In subsection 3.B.1, it was noted that optimal income tax analysis often considers SWFs of an isoelastic form (see expression 3.2), where the parametereindicates society’s degree of aversion to inequality in utility levels:e= 0 corresponds to the utilitarian SWF and higher levels ofeto strictly concave SWFs. (The limiting case, aseapproaches infinity, yields the maximin formulation suggested by Rawls (1971), placing...

    • (pp. 391-406)

      For purposes of assessing taxation and redistribution, chapters 13 and 14 present a complete framework. That is, once it is decided that social welfare should depend exclusively on individuals’ utilities, what the functional form of the SWF is, and whose utilities count, it would appear that there is no room for further normative analysis, much less for additional and potentially conflicting normative criteria.

      This approach to distributive justice and social welfare, however, became established in applied work only with the emergence of the literature on optimal income taxation in the 1970s. Before then, more informal, intuitive notions of tax equity...

  7. (pp. 407-416)

    The theory of taxation and public economics is usefully conceptualized in terms of a core framework. The setting is the world of the two fundamental theorems of welfare economics, modified to include an income tax to accomplish redistribution in light of the infeasibility of distortion-free individualized lump-sum taxes. The analysis is characterized by explicit attention to the social objective of welfare maximization in determining how multiple instruments are best used to achieve it.

    The presence of the income tax and the related second-best problem involving the tradeoff of distribution and labor supply distortion have a substantial qualitative influence on how...