Taxation and the Relative Prices of Factors of Production

Abstract

ONE of the most important consequences of the raising and spending of taxes is the resulting change in relative factorprices. Yet writers have paid surprisingly little attention to this. When considering the effects of a tax upon the production or sale of a particular commodity, they have considered mainly the effect upon the price of that commodity. If the amount of any factor employed in producing a particular commodity is small relatively to the total supply of that factor, the effect of such a tax on relative factor-prices may be negligible; but when this is not so, or when a number of commodities are subjected to such a tax, it may be of great importance. Similarly, discussions of the effects of an incometax have centred around such questions as whether income-tax enters into commodity prices, whether it discriminates against saving, and whether it stimulates or checks the supply of work and saving. Little attention has been given to its effect upon relative factor-prices. In order to consider briefly how the raising and spending of taxes affect the relative prices of factors of production, I shall make a number of simplifying assumptions. I shall assume that only two commodities are or can be produced-say wheat and steel. I shall assume that there are only two factors-say land and labour-and that any unit of land is a perfect substitute for any other unit of land in the production of either commodity, and similarly that any unit of labour is a perfect substitute for any other unit of labour in the production of either commodity. I shall further assume that tastes and knowledge and supplies of factors remain constant during the period under discussion, that there is perfect competition, and that the economy is in equilibrium before the tax is imposed and reaches a new equilibrium after the tax has been imposed. The problem concerns the relative prices of land and labour in