Public Economics
                                   Taxation II: Optimal Taxation
                                                 Iñigo Iturbe-Ormaetxe
                                                          U. of Alicante
                                                         Winter 2012
     I. Iturbe-Ormaetxe (U. of Alicante)     Public Economics Taxation II: Optimal Taxation                  Winter 2012      1 / 98
   Outline
        1  Commodity Taxation I: Ramsey Rule
        2  Commodity Taxation II: Production E¢ ciency
        3  Income Taxation I: Mirrlees Model
     I. Iturbe-Ormaetxe (U. of Alicante) Public Economics Taxation II: Optimal Taxation            Winter 2012     2 / 98
    Optimal Commodity Taxation: Introduction
             Weuse what we know about incidence and e¢ ciency costs to analyze
             optimal design of commodity taxes
             What is the best way to design taxes given equity and e¢ ciency
             concerns?
             The literature on optimal commodity taxation focuses on linear tax
             systems
             Non-linear tax systems are studied with income taxation
     I. Iturbe-Ormaetxe (U. of Alicante)     Public Economics Taxation II: Optimal Taxation                  Winter 2012      3 / 98
    Second Welfare Theorem
             The starting point is the Second Theorem of Welfare Economics: any
             Pareto optimal outcome can be achieved as a competitive equilibrium
             with appropriate lump-sum transfers of wealth
             This result requires the same assumptions as the First Theorem plus
             one more (and some convexity requirements):
                1    Complete markets (no externalities)
                2    Perfect information
                3    Perfect competition
                4    Lump-sum taxes/transfers across individuals feasible
             If all assumptions hold, there is no equity-e¢ ciency trade-o¤ and the
             optimal tax problem is trivial. Implement LSTs that meet
             distributional goals given revenue requirement
             Problem: information
     I. Iturbe-Ormaetxe (U. of Alicante)     Public Economics Taxation II: Optimal Taxation                  Winter 2012      4 / 98