Public Finance, 2nd Edition

1. If commodity taxes are not used, then the possibility of evasion does

not change the standard result that the marginal tax rate is zero on the high-

ability people and positive on the low-ability people.

2. Starting from zero commodity taxes, the imposition of a uniform

commodity tax is welfare improving.

3. Given an income tax, a uniform commodity tax is optimal if prefer-

ences are separable between the commodities and leisure and also quasi-

homothetic in the commodities. The model is too complex to lead to a simple

characterization of the optimal pattern of commodity taxes when this condi-

tion is not satisWed and diVerentiated commodity taxation is called for.

In conclusion, the analysis in the section underscores the important point

that the design of a tax system depends crucially on what the government can

tax and what form the taxes can take. Both issues depend in large part on the

information available to the government.

OPTIMAL INCOME TAXATION

The analysis of optimal income taxation was a natural research topic in the

1970s for economists interested in the properties of restricted taxation. The

personal income tax had become the single most important tax in most of the

developed market economies, as well as the main tax instrument for redistrib-

uting purchasing power. As such, the income tax was the obvious candidate

for exploring the equity±eYciency trade-oV in taxation.

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On the equity side, the income tax has considerable redistributive power

because it can be so easily tailored to the personal and economic characteris-

tics of individuals and families through such features as personal exemptions

to protect the poor and graduated tax rates that tax high incomes in a very

progressive manner. On the eYciency side, the income tax suVers from

Okun's leaky bucket with its three main sources of leaks:

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The mainstream view of redistribution was (and still is) that it is a negative sum game

because of the eYciency losses from the distorting taxes and transfers (i.e., Okun's leaky bucket).

Some recent literature is trying to recover an older notion in political economy that redistribution

can be a positive sum game because the transfers improve the productivity of the poor. This idea

is particularly persuasive in some less-developed countries in which the poor may have such

nutritionally poor diets absent redistribution that they do not have the strength to work. The

possibility of positive-sum redistribution is also gaining support in the context of developed

market economies as well. HoV and Lyon recently developed a model in which the distortions

from wage taxation are more than oVset by the productivity gains of the subsidies they Wnance, at

least at suYciently low levels of taxes and subsidies. The subsidies increase productivity because

they are targeted to the education of the poor, who would otherwise be shut out of the market for

higher education by market imperfections. See K. HoV and A. Lyon, ``Non-Leaky Buckets:

Optimal Redistributive Taxation and Agency Costs,'' Journal of Public Economics, November

1995.

15. TAXATION UNDER ASYMMETRIC INFORMATION 503