The Measurement of Deadweight Loss Revisited

Abstract

modities (such as various consumer goods and labor), M fixed factors (such as land, natural resources and various types of fixed capital), and a government which taxes commodities and fixed factors in order to finance various govern- ment expenditures. It is well known2 that if the government can raise its required revenue by taxing the fixed factors alone, then the resulting allocation of resources is Pareto optimal-no single household's utility or real income can be increased without decreasing the utility of some other household. Suppose we are at an initial equilibrium where government revenue is being raised by taxing the fixed factors alone. Then the resulting equilibrium can be rationalized by maximizing a certain weighted sum of utility functions subject to various feasibility constraints. Now think of the government replacing the taxes on fixed factors with distortionary commodity taxes. In Section 3, we calculate the second order directional derivative of the above weighted sum of utility functions with respect to any feasible direction of tax change, evaluated at the initial equilibrium which is Pareto optimal. Of course, the first order directional derivatives of the weighted sum of utility functions with respect to feasible directions of tax change are zero evaluated at this initial equilibrium. We obtain a measure of economic due to tax distortions which is virtually identical to that of Boiteux (3, p. 113) and which bears a resemblance to the dead loss of Hotelling (22, p. 254), the consumer's surplus measures of Hicks (19; 20, pp. 330-3), and the deadweight loss measure of Harberger (16, p. 61; 17, p. 788). In Section 4, we calculate a measure of welfare based on Debreu's (4, 5) coefficient of resource utilization (which is a modification of a measure of due to Allais (1, 2)) and we show that under certain conditions, the Hotelling,