Determining the Optimal Tax Rate Using a Dynamic Approach to the Optimal Control Theory

Abstract

Up to now, numerous tax bases with different rates have been identified in Iran's economy. The questions are “Are these rates optimal?” and “Is it possible to determine an average optimal rate in a way that it would bring greater growth and prosperity?”. In the present study, we seek to determine Iran's optimal tax rates using time series data in the years 1978-2014, a dynamic optimal control approach, and the maximum principle. According to the findings, the main factors affecting the optimal tax rate include the ratio of expenditures of the private sector to the public sector, the ratio of investment in the public sector to the private sector, depreciation rate, rate of time preference, elasticity of production function to the investment in the private sector and the public sector, and technical progress. Among the above factors, the ratio of expenditures of the private sector to the public sector has a negative effect, and the ratio of investment in the public sector to the private sector has a positive effect on the optimal tax rate. The other variables have no significant effect on the optimal tax rate. In addition, the optimal tax rate is 20 percent. Since there are several tax bases in Iran, average tax rates should be close to the optimal rate. Changes in tax rates should be according to the economic conditions of boom and bust. In this regard, finding new tax bases to reduce the negative effects of changes in tax rates is very important.