Automobile Emissions 263
Industrial Air Pollution 263
Industrial Water Pollution 266
Toxic Substances 267
The EVectiveness of U.S. Antipollution Policies 269
9 The Theory of Decreasing Cost Production
Decreasing Cost in General Equilibrium Analysis 273
The Pareto-Optimal Conditions 275
Decreasing Cost and Competitive Markets 276
The Optimal Pricing Rule 278
The Optimal Investment Rules 280
Decreasing Cost Services and Public Goods 295
ReXections on U.S. Policy Regarding Decreasing Cost Services:
The Public Interest in Equity and EYciency 297
Equity Considerations 299
EYciency Considerations 302
References 304
Appendix: Returns to Scale, Homogeneity, and Decreasing
Cost 304
10 The First-Best Theory of Taxation
Public Choice and Pareto-Optimal Redistribution 309
Pareto Optimality and the Overall Distribution of
Income 311
Pareto-Optimal Redistribution and the Poor 313
What Motivates Charity: Should Aid Be In-Kind or
Cash? 315
Are Pareto-Optimal Redistributions Enough? 320
Altruism, Free Riding, and Crowding Out of Private
Charity 322
Do People Free Ride? 322
Does Public Assistance Crowd Out Private Giving? 324
Other Motivations for Redistributive Transfers 326
Public Insurance 326
Social Status 327
Equal Access 328
References 328
x CONTENTS
11 Applying First-Best Principles of TaxationÐWhat
to Tax and How
Designing Broad-Based Taxes: The Economic
Objectives 332
Ability to Pay: Theoretical Considerations 334
Two Preliminary Considerations 335
Horizontal Equity 337
From Horizontal Equity to the Ideal Tax Base 337
Haig±Simons Income 338
Criticisms of Haig±Simons Income 341
Haig±Simons Income Versus Expenditures: Musgrave's
Perspective 348
Horizontal Equity and the Interpersonal Equity
Conditions 349
Vertical Equity 352
Progressive, Proportional, and Regressive Taxes 352
Vertical Equity and the Interpersonal Equity
Conditions 353
SacriWce Principles of Vertical Equity 354
Young's Prescription for Vertical Equity 356
Vertical Equity in the United States 361
ReXections on the Haig±Simons Criterion in Practice: The Federal
Personal Income Tax 362
Personal Income 362
Capital Gains 363
The Taxation of Personal Income: The Tax
Loopholes 364
The Taxation of Capital Gains: InXation Bias and
Realization 370
The InXationary Bias Against Income from Capital 370
Taxing Realized Gains: Auerbach's Retrospective Taxation
Proposal 373
Capital Gains Taxation: A Postscript 378
The Taxation of Human Capital 378
Summary 382
References 382
CONTENTS xi
III THE THEORY OF PUBLIC EXPENDITURES AND
TAXATION: SECOND-BEST ANALYSIS
12 Introduction to Second-Best Analysis
A Brief History of Second-Best Theory 390
Second-Best Tax Theory 391
Second-Best Expenditure Theory 391
Private Information 393
Philosophical and Methodological Underpinnings 396
Preview of Part III 397
References 398
13 The Second-Best Theory of Taxation in One-
Consumer Economies with Linear Production
Technology
General Equilibrium Price Models 401
The Measurement of Loss from Distorting Taxes 402
The Geometry of Loss Measurement: Partial Equilibrium
Analysis 403
The Geometry of Loss Measurement: General Equilibrium
Analysis 404
The Analytics of General Equilibrium Loss
Measurement 409
Policy Implications of the Loss Measures 417
The Optimal Pattern of Commodity Taxes 429
Policy Implications of the Optimal Tax Rule 432
Substitutions Among Taxes: Implications for Welfare Loss 439
The Corlett and Hague Analysis 441
References 444
14 The Second-Best Theory of Taxation with
General Production Technologies and Many
Consumers
A One-Consumer Economy with General Technology 448
Dead-Weight Loss from Taxation 448
xii CONTENTS
Optimal Commodity Taxation 458
Many-Person Economies: Fixed Producer Prices 461
Social Welfare Maximization Versus Loss
Minimization 461
Optimal Commodity Taxation in a Many-Person
Economy 465
U.S. Commodity Taxes: How Far From Optimal? 472
Many-Person Economy with General Technology 474
Optimal Taxation 477
The Social Welfare Implications of any Given Change in
Taxes 478
References 482
15 Taxation Under Asymmetric Information
Lump-Sum Redistributions and Private Information 487
Redistribution Through Commodity Taxation 489
Optimal Taxation, Private Information, and Self-Selection
Constraints 493
Elements of the Model 494
Pareto-EYcient Taxation 497
An Extension: The Direct-Indirect Tax Mix 502
Optimal Income Taxation 503
The Shape of the Tax Schedule 508
Concluding Observations 511
Tax Evasion 512
Increasing the Penalty 515
Increasing Monitoring 515
Revenue-Raising Strategies 516
Tax Amnesties 519
Concluding Remarks 519
References 521
16 The Theory and Measurement of Tax Incidence
Tax Incidence: A Partial Equilibrium Analysis 524
First-Best Theory, Second-Best Theory, and Tax Incidence 525
Methodological DiVerences in the Measurement of Tax
Incidence 527
Theoretical Measures of Tax Incidence 528
General Principles of Tax Incidence 530
CONTENTS xiii
The Disposition of the Tax Revenues 530
Welfare Measures of Tax Incidence: One-Consumer
Economy 534
The Relative Price Measure of DiVerential Tax Incidence:
One-Consumer Economy 537
The Equivalence of General Taxes 540
Theorem: The Equivalence of General Taxes 541
Measuring Tax Incidence: A Many-Consumer Economy 546
The Individual Perspective on Incidence 546
The Aggregate Social Welfare Perspective on
Incidence 548
The Harberger Analysis 549
Geometric-Intuitive Analysis 551
The Harberger Analytics 554
Important ModiWcations of the Harberger Model 566
Variable Factor Supplies 566
Oligopoly and the Corporation Income Tax 569
Heterogeneous Consumers 570
References 571
17 Expenditure Incidence and Economy-Wide
Incidence Studies
The Incidence of Government Transfer Payments 575
Tax and Expenditure Incidence with Decreasing-Cost
Services 578
Samuelsonian Nonexclusive Goods 579
The Incidence of Nonexclusive Goods: Empirical
Evidence 583
Economy-Wide Incidence Studies 585
The Sources and Uses Approach 586
Annual Incidence Studies 587
The Pechman±Okner Studies 588
Mixing Annual and Lifetime Incidence 593
Pure Lifetime Tax Incidence 595
Lorenz±Gini Measures of Tax Incidence 597
Computable General Equilibrium Models of Tax
Incidence 603
Dynamic Tax Incidence 606
The Auerbach±KotlikoV OLG Model 607
The Fullerton±Rogers Lifetime CGE Model 619
References 622
xiv CONTENTS
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