Consumption taxation for redistribution

Abstract

This paper explores the optimal behaviour of a government intent on redistributing from the top to the bottom of the earnings distribution, whose tax-transfer instruments are weaker than those assumed by Mirrlees (1971) but stronger than those assumed by Sheshinski (1972). I prove that one may obtain fi rst-order welfare gains by switching from Sheshinski's linear progressive tax-transfer system to one based on consumption taxation. In addition, I show the Atkinson-Stiglitz Theorem rests on unrestricted nonlinear earnings taxation. In an optimal progressive earnings and consumption tax-transfer system the Corlett-Hague understanding of the Ramsey tax problem - tax goods more complementary with leisure, holding utility constant, at higher rates, even if leisure is additively separable from goods - plays an important role. As redistribution proceeds this force is counterbalanced by the Mirrleesian result that taxing the work effort of lower wage types is an efficient way to cope with incentive compatibility constraints.