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Laffer effect, gross substitution, marginal cost of public funds and the level property of public good provision

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  • Ming Chang
  • Hsiao-Ping Peng

Abstract

This paper examines the Laffer effect in the Ramsey tax-model with linear consumption taxes and a representative consumer. It is assumed that the private goods and the public good are weakly separable. It is demonstrated that if all of the private goods are weak gross complements to each other, then the Laffer effect does not exist, in other words, higher tax rates can always achieve more tax revenue. In contrast, if all of the private goods are strict gross substitutes, then the Laffer effect does exist. Moreover, if all of the private goods are weak gross substitutes, then the government cannot fully acquire the leisure endowment through taxes on consumption goods. We also show that gross substitution works to raise the marginal cost of public funds. Copyright Springer Science+Business Media, LLC 2012

Suggested Citation

  • Ming Chang & Hsiao-Ping Peng, 2012. "Laffer effect, gross substitution, marginal cost of public funds and the level property of public good provision," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 19(5), pages 650-659, October.
    • Handle: RePEc:kap:itaxpf:v:19:y:2012:i:5:p:650-659
    DOI: 10.1007/s10797-011-9200-1
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    More about this item

    Keywords

    Laffer effect; Gross substitution; Gross complementarity; Marginal cost of public funds; Leisure complements; H21; H41;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H41 - Public Economics - - Publicly Provided Goods - - - Public Goods

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