Optimum Commodity Taxation When Employment Matters

Abstract

Ramsey's inelasticity rule for optimum commodity taxation has been criticized for indicating tax rates for basic necessities which have lower elasticities of demand than luxury consumption items. However, it is noted that skillful marketing techniques tend to lower the demand elasticities of luxury items so that it is not evident that the Ramsey rule is inequitable. In this paper equity concerns from a macroeconomic viewpoint are introduced, modifying the Ramsey rule approach by including total employment in the decision-maker's utility function. Then it is seen that the relative tax rate of the product which is more labour-intensive in production is lower than under the original Ramsey rule. The weight given by the government to an additional unit of employment relative to additional tax revenue now enters the tax rule specification. It is also observed that when the employment objective is included, the relative tax rates of products such as furniture that are labour-intensive in production will be lower than under the pure Ramsey inelasticity rule.