Do we need ramsey taxation? Our existing taxes are largely corrective

Abstract

Due to the importance of environmental disruption (both in production and consumption), relative competition between individuals (including conspicuous consumption and keeping up with the Joneses), the diamond effect, excessive consumerism or the materialist bias, most taxes in most countries, though mainly designed for revenue collection, are largely corrective than distortive. There is thus no need for Ramsey taxation. In this paper, a theoretical model is built to make a comparison between the social optimality attained by an income tax and the individual optimality attained without an income tax. Relative competition and environmental disruption reinforce each other in causing excessive work and excessive pollution. An income tax is shown to reduce these double departures (from social optimality) of both leisure and environmental quality. The empirical test conducted on the data from the World Bank and the International Labor Organization conforms to this theoretical finding. More concretely, when the labor tax increases by 1 standard deviation from the average level, the average working time may be reduced by 1.125%. And when there is a higher profit tax than the average level by 1 standard deviation, about 6% of the cross-country average level of carbon damage in the sample may be reduced.