Optimum commodity taxation in pooling equilibria

Eytan Sheshinski*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract

This paper extends the standard model of optimum commodity taxation (Ramsey, F., 1927. A Contribution to the Theory of Taxation. Economic Journal 37, 47-61; Diamond, P., Mirrlees, J., 1971. Optimal Taxation and Public Production, II: "Tax Rules". American Economic Review 61, 261-278) to a competitive economy in which markets are inefficient due to asymmetric information. Insurance markets are prime examples: consumers impose varying costs on suppliers but firms cannot associate costs with individual customers and consequently all are charged equal prices. In such a competitive pooling equilibrium, the price of each good is equal to the average of individual marginal costs weighted by equilibrium quantities. We derive modified Ramsey-Boiteux Conditions for optimum taxes in such an economy and show that, in addition to the standard formula, they include first-order effects which reflect the deviations of prices from marginal costs and the response of equilibrium quantities to the taxes levied. An explanation of the additional terms is provided. It is shown that a condition on the monotonicity of demand elasticities enables to sign the direction of the deviations from the standard case.

Original languageEnglish
Pages (from-to)1565-1573
Number of pages9
JournalJournal of Public Economics
Volume91
Issue number7-8
DOIs
StatePublished - Aug 2007

Keywords

  • Annuities
  • Asymmetric information
  • Pooling equilibrium
  • Ramsey-Boiteux Conditions

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