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Reforming the Direct–Indirect Tax Mix

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  • Michael Smart

Abstract

This paper provides a new framework for evaluating the welfare effects of commodity tax reforms. It is shown that tax reforms are welfare improving if and only if they satisfy the following intuitive property: on average, consumer prices fall for commodities with high marginal excess burdens. The rule is then applied to analyze a shift from differentiated commodity taxation to direct flat-rate taxation of labour income. The welfare impact of such reforms can be decomposed into two effects: (i) the increase in welfare associated with substitution among taxed commodities, and (ii) the loss in welfare associated with substitution between commodities and leisure. On balance, a shift towards direct taxation is desirable when inter-commodity substitution effects are large relative to commodity–leisure substitution effects. The analysis allows us to reconcile the apparently conflicting results of the tax reform and optimal taxation literatures. Copyright Kluwer Academic Publishers 2002

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  • Michael Smart, 2002. "Reforming the Direct–Indirect Tax Mix," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 9(2), pages 143-155, March.
    • Handle: RePEc:kap:itaxpf:v:9:y:2002:i:2:p:143-155
    DOI: 10.1023/A:1014647403564
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    1. Murata, Yasuo, 1977. "Mathematics for Stability and Optimization of Economic Systems," Elsevier Monographs, Elsevier, edition 1, number 9780125112505 edited by Shell, Karl.
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    Cited by:

    1. Stefan Homburg, 2004. "A New Approach to Optimal Commodity Taxation," CESifo Working Paper Series 1231, CESifo.
    2. Stefan Homburg, 2006. "A New Approach to Optimal Commodity Taxation," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 62(3), pages 323-338, September.
    3. Yoshitomo Ogawa, 2007. "The optimal commodity tax structure in a four-good model," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 14(6), pages 657-671, December.
    4. José Sánchez Maldonado & Salvador Gómez Sala, 2006. "The Reform of Indirect Taxation in Spain: VAT and Excise," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper0607, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.

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