Optimal Taxation of Consumption and Income

Abstract

Optimal taxation and tax system design both involve important tradeoffs with respect to efficiency and fairness, and researchers in the fields of public finance and applied economics have analyzed these issues for many years. In this study, while the focus is primarily on optimal consumption and income taxes, we first explain the concepts of excessive burden and efficiency as they relate to this topic. Then, we examine optimal taxation and the structure of an optimal tax system. Lastly, we address optimal consumption and income taxes, emphasizing theoretical discussions on their impact on the economy. The aim of this study is to reveal how the concepts of optimal consumption and income taxes are related, through a literature review, and to examine whether theoretical studies have influenced tax policies. This review reveals that studies of optimal tax theory focus on (i) flat rate taxation of income, (ii) zero marginal tax rates on high income, and (iii) shifting taxation to indirect taxes, and that these concepts have been reflected in tax reforms. However, we find that optimal taxation does not mean that every country applies or should apply these concepts in the same way; they should be considered according to the specific socio-economic structures of developed and developing countries, in a way that reflects each society. While discussions on optimal tax theory from the past to the present must take place within a framework of efficiency and fairness, discussions of optimality in taxation will continue into the future with developments in technology. In addition, factors such as a country’s level of economic development, international tax competition, capital flows, and environmental factors will keep the issue politically alive.