Abstract
Following Ramsey, the existing literature on optimal quantity taxation only compares the pre and the post-tax market equilibriums in order to account for the efficiency losses. However, when the government imposes a quantity tax on the consumer, the buyer’s price jumps to the pre-tax equilibrium price plus the amount of the tax, and the supply and the demand of the taxed commodity then adjust over time to bring the new post-tax market equilibrium. The existing literature does not take into account the efficiency losses during the adjustment process while computing the optimal quantity taxes. This paper derives an optimal quantity tax path in a dynamic setting minimizing the efficiency losses (output and/ or consumption lost) during the dynamic adjustment process as well as the post-tax market equilibrium.
Highlights
Optimal taxation in theory is the design of a tax that minimizes inefficiency and distortion due to deviation from the pre-tax efficient market equilibrium under given economic constraints. Ramsey (1927) was the first to make a significant contribution to the theory of optimal taxation from an economic standpoint
When a government imposes a quantity/ commodity tax on the consumer, the price jumps to the pre tax equilibrium price plus the amount of the tax
The demand and supply adjust over time to bring the new post tax equilibrium
Summary
Optimal taxation in theory is the design of a tax that minimizes inefficiency and distortion due to deviation from the pre-tax efficient market equilibrium under given economic constraints. Ramsey (1927) was the first to make a significant contribution to the theory of optimal taxation from an economic standpoint. Ramsey (1927) was the first to make a significant contribution to the theory of optimal taxation from an economic standpoint He developed a theory for optimal commodity taxes and proposed a theoretical solution that consumption tax on each good should be "proportional to the sum of the reciprocals of its supply and demand elasticities". Following Ramsey, the existing literature on optimal quantity taxation only compares the pre and the post-tax market equilibriums in order to account for the efficiency losses. This paper derives an optimal quantity tax path in a dynamic setting minimizing the efficiency losses (output and/ or consumption lost) during the dynamic adjustment process as well as the post-tax market equilibrium.
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