Choosing The Tax Rate in a Linear Income Tax Structure: An Introduction

John Creedy

No 1006, Department of Economics - Working Papers Series from The University of Melbourne

Abstract: This paper provides an introduction to modelling the choice of linear income tax rate in both majority voting and social welfare maximising contexts. Although the basic problem in each case — of finding the most preferred tax for the median voter and the welfare maximising tax for an independent judge or decision-maker — can be simply stated, it is usually not possible to obtain explicit solutions even for simple assumptions about preferences and population heterogeneity. The present paper instead gives special attention to a formulation of the required conditions in terms of easily interpreted magnitudes, the elasticity of average earnings with respect to the tax rate and a measure of inequality. The inequality measure takes the same basic form in each model (depending either on median earnings or a weighted average of earnings, where the weights depend on value judgements regarding inequality aversion. The approach enables the comparative static effects of a range of parameter changes to be considered. The results are reinforced using numerical examples based on the constant elasticity of substitution utility function.

Pages: 30 pages
Date: 2007
New Economics Papers: this item is included in nep-dcm
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