Economic Quarterly

2009

 

Summer 2009

Distortionary Taxation for Efficient Redistribution

Borys Grochulski

This article uses a simple model to review the economic theory of efficient redistributive taxation. The model economy is a Lucas-tree economy, in which income comes from a stock of productive capital. Agents, who own the capital stock, are heterogenous with respect to their preference for early versus late consumption. A competitive capital market, in equilibrium, supports a unique Pareto-efficient allocation of consumption among the agents, i.e., the First Welfare Theorem holds. The equilibrium allocation represents one efficient division of the total gains from trade that are available in the economy. All other efficient divisions of the gains from trade, represented by a continuum of other Pareto-efficient allocations, are inconsistent with competitive capital market equilibrium. If agents' preference types are public information, nondistortionary wealth transfers are sufficient to implement any Pareto optimum as a market equilibrium, i.e., the classic Second Welfare Theorem holds. If agents' preferences are private information, however, the classic Second Welfare Theorem fails. A class of distortionary tax systems is characterized under which a modified Second Welfare Theorem holds: Every constrained-Pareto-optimal allocation can be supported as an equilibrium subject to distortionary taxes.

Contact Us

Richmond

Amanda L. Kramer
(804) 697-8606

Publications image
Get Our Free Publications

To receive a notification by email when Economic Quarterly is posted online or to order single copies of past issues, click on the links below (published online only since 2012).