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Income taxes as reciprocal tariffs

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  • W. Michael Cox
  • David M. Gould
  • Roy J. Ruffin

Abstract

This article shows the equivalence between tariffs on international trade and income taxation. Traditionally, income taxes have been seen as lowering society's output through the household's labor-leisure trade-off. Income taxes also reduce the degree to which individuals specialize in market activity, which is similar to the way countries respond to tariffs in international trade. Income taxes discourage individuals from specializing in activities that reflect their comparative advantage. In so doing, income taxes may have their most distorting effects, not by encouraging individuals to work less but by causing them to spend more time working at endeavors for which their talent is limited. Using a general model of interpersonal exchange, the authors demonstrate parallels between income taxes and tariffs. Over a range of income taxes, raising taxes can benefit large groups of similarly skilled individuals and hurt small groups. As in tariff theory, the costs of income taxes are small only if they succeed in raising revenue. Thus, it is very costly for an economy to be on the downward portion of its tax revenue (Laffer) curve. The more heterogeneous the society, the higher the income tax rate that will maximize tax revenues. By overlooking the effects of heterogeneity in the workforce and the potential for workers to flee to home production, policymakers may under- or overestimate the effects of income taxes on various sectors of the economy and tax with unintended consequences.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • W. Michael Cox & David M. Gould & Roy J. Ruffin, 1993. "Income taxes as reciprocal tariffs," Working Papers 9336, Federal Reserve Bank of Dallas.
    • Handle: RePEc:fip:feddwp:9336
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    References listed on IDEAS

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    1. Roy Ruffin, 1979. "Border tax adjustments and countervailing duties," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 115(2), pages 351-355, June.
    2. McGrattan, Ellen R & Rogerson, Richard & Wright, Randall, 1997. "An Equilibrium Model of the Business Cycle with Household Production and Fiscal Policy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(2), pages 267-290, May.
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    5. Eisner, Robert, 1989. "The Total Incomes System of Accounts," University of Chicago Press Economics Books, University of Chicago Press, edition 1, number 9780226196381, December.
    6. Peter M. Mieszkowski, 1967. "On the Theory of Tax Incidence," Journal of Political Economy, University of Chicago Press, vol. 75(3), pages 250-250.
    7. Sandmo, Agnar, 1990. "Tax Distortions and Household Production," Oxford Economic Papers, Oxford University Press, vol. 42(1), pages 78-90, January.
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    Keywords

    Tariff; Taxation;

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