From Optimal Tax Theory to Tax Policy: Retrospective and Prospective Views

301 Pages·2012·1.8 MB·English

by  Robin Boadway

From Optimal Tax Theory to Tax Policy
Munich Lectures in Economics
edited by Hans-Werner Sinn
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From Optimal Tax Theory to Tax Policy: Retrospective and Prospective
Views, by Robin Boadway
In cooperation with the council of the Center for Economic Studies of
the University of Munich

Martin Beckman, David F. Bradford, Gebhard Flaig, Otto Ganden-
berger, Franz Gehrels, Martin Hellwig, Bernd Huber, Mervyn King,
John Komlos, Richard Musgrave, Ray Rees, Bernd Rudolph, Agnar
Sandmo, Karlhans Sauernheimer, Klaus Schmidt, Hans Schneeweiss,
Robert Solow, Joseph E. Stiglitz, Wolfgang Wiegard, Charles Wyplosz
From Optimal Tax Theory to Tax Policy
Retrospective and Prospective Views
Robin Boadway
The MIT Press
Cambridge, Massachusetts
London, England
© 2012 Massachusetts Institute of Technology
All rights reserved. No part of this book may be reproduced in any form by any electronic
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This book was set in Palatino by Toppan Best-set Premedia Limited. Printed and bound
in the United States of America.
Library of Congress Cataloging-in-Publication Data
Boadway, Robin W., 1943 –
From optimal tax theory to tax policy : retrospective and prospective views / Robin
Boadway.
p. cm. — (Munich lectures in economics)
Includes bibliographical references and index.
ISBN 978-0-262-01711-4 (hardcover : alk. paper)
1. Taxation. 2. Fiscal policy. I. Title.
HJ2305.B63 2012
336.2001 — dc23
2011028993
10 9 8 7 6 5 4 3 2 1
Contents
Series Foreword vii
Acknowledgments ix
1 Introduction 1
2 From Tax Theory to Policy: An Overview 7
2.1 Landmarks of Optimal Tax Theory 7
2.2 The Evolution of Policy and Advice 16
2.3 Challenges for the Theory of Tax Policy 26
2.3.1 Commitment 26
2.3.2 Heterogeneity of Individual Utility Functions 30
2.3.3 Behavioral Issues 34
2.3.4 Responsibility and Compensation 37
2.3.5 Political Economy 38
2.4 Optimal Analysis versus Reform Analysis 40
2.5 Summary of Lessons for Tax Policy 44
3 Policy Lessons from Optimal Tax Theory 47
3.1 Uniformity of Commodity Taxes 51
3.1.1 The Corlett – Hague Theorem 51
3.1.2 The Atkinson – Stiglitz Theorem 58
3.2 Production Effi ciency: Implications and Caveats 77
3.3 Capital Taxation and the Personal Tax Base 85
3.3.1 Linear Taxation in a Dynamic Setting 86
3.3.2 Nonlinear Taxation in a Dynamic Setting 95
3.4 The Issue of Progressivity 106
3.5 Asymmetric Information and Market Failure 124
3.6 Policy Lessons from Normative Analysis 133
vi Contents
3.6.1 Uniform Broad-Based Commodity Taxation 134
3.6.2 Production Effi cient Taxation 135
3.6.3 Taxation of Asset Income 135
3.6.4 Progressivity 136
3.6.5 Business Taxation 137
4 Relaxing the Second-Best Constraints 139
4.1 The Use of Supplementary Policy Instruments 143
4.1.1 Differential Commodity Taxes 144
4.1.2 Public Goods and the Marginal Cost of Public Funds 146
4.1.3 Quantity Controls: In-kind Transfers 148
4.1.4 Price Controls 153
4.1.5 Workfare 157
4.1.6 Other Issues Affecting Instrument Choice 162
4.2 Making Use of, and Acquiring, More Information 168
4.2.1 Tagging 169
4.2.2 Monitoring 174
4.3 Conclusions 182
5 Challenges for Second-Best Analysis 185
5.1 Fundamentals of the Standard Approach 185
5.2 The Commitment Issue 193
5.3 Heterogeneous Preferences and Utility 199
5.3.1 Needs 201
5.3.2 Disutility of Work 202
5.3.3 Other Dimensions of Taste Differences 204
5.3.4 Interdependent Utilities 205
5.3.5 Dealing with Differences in Preferences: One Proposed
Approach 212
5.4 Behavioral Issues 217
5.4.1 Bounded Rationality 218
5.4.2 Irrational Choices 220
5.4.3 Nonselfi sh Choices 225
5.4.4 Happiness 228
5.5 Political Economy 229
5.6 Concluding Comments 239
References 243
Index 269
Series Foreword
Every year the CES council awards a prize to an internationally
renowned and innovative economist for outstanding contributions to
economic research. The scholar is honored with the title “ Distinguished
CES Fellow ” and is invited to give the “ Munich Lectures in
Economics. ”
The lectures are held at the Center for Economic Studies of the Uni-
versity of Munich. They introduce areas of recent or potential interest
to a wide audience in a nontechnical way and combine theoretical
depth with policy relevance.

Hans-Werner Sinn
Professor of Economics and Public Finance
Director of CES
University of Munich

Acknowledgments
This work draws liberally on joint work with many authors including
Neil Bruce, Emma Chamberlain, Katherine Cuff, Carl Emmerson,
Firouz Gahvari, Richard Harris, Laurence Jacquet, Michael Keen,
Nicolas Marceau, Steeve Mongrain, Maria Racionero, Motohiro Sato,
Jean-Fran ç ois Tremblay, Marianne Vigneault, and David Wildasin. I am
especially indebted to Pierre Pestieau for ongoing discussions, collabo-
ration, and stimulation on the ideas in this study, and to the late Maurice
Marchand from whom I learned many lessons about both economic
and normative analysis. I am very grateful for the assistance and advice
from Alex Armstrong, Jean-Denis Garon, Adnan Khan, and Louis Per-
rault, each of whom contributed to parts of the study. Nicholas Ches-
terley provided helpful detailed comments on an earlier draft, and
made many well-taken suggestions for improvement in the content
and coverage. To all these contributors, I am enormously grateful. I am
also indebted to the Center for Economic Studies at the University of
Munich and its members, especially Hans-Werner Sinn, for giving me
the opportunity to prepare this book and the lectures on which it is
based. Of course, the shortcomings of the current project are my
responsibility.