Reforming the Direct–Indirect Tax Mix

Michael Smart

International Tax and Public Finance, 2002, vol. 9, issue 2, 143-155

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

Keywords: uniform commodity taxation; tax reform; excess burden (search for similar items in EconPapers)
Date: 2002
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DOI: 10.1023/A:1014647403564

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