Home Business & Finance Principles of Public Finance
Application to Some Examples
Enlarging the Tax Base
Consider a tax reform aimed at enlarging the tax base for all consumption goods except those related to leisure. The desirability of this reform is judged according to whether it depresses labor supply, which is not included as a tax base after the reform.
As explained in Chap. 8, with regard to the Cobb-Douglas utility function, labor supply is independent of consumption good prices; hence, this tax reform does not affect labor supply. It follows that it is desirable to enlarge the tax base. As a result, it is optimal to tax uniformly all consumption goods with a uniform consumption tax or, with regard to the Cobb-Douglas utility function, to tax labor income only with a labor income tax.
Unifying Tax Rates
Next, consider a tax reform aimed at imposing a uniform tax rate on goods that are initially taxed at different rates. This reform is the same as the foregoing reform that enlarges the uniform tax base.
This similarity arises because enlarging the tax base may be regarded as integrating tax rates from initially different rates, which include a zero rate, with a uniform rate. Thus, if the value added of taxable goods does not decline or the value added of a non-taxable good, leisure, does not increase, unifying tax rates is desirable. With regard to the Cobb-Douglas utility function, uniform tax structure is always desirable.
We have shown how the fundamental reform rule may be applied to the reform of an enlarged tax base or the integration of tax rates. This criterion may be useful because information on changes in consumption goods is readily available.
|< Prev||CONTENTS||Next >|