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1. The Benefit Principle of Taxation 1.1 The Optimum Supply of Public Goods

LECTURE “TAXATION ECONOMICS” AT STATE UNIVERSITY – HIGHER SCHOOL OF ECONOMICS by Professor Dr. Christian SEIDL, University of Kiel, Germany. 1. The Benefit Principle of Taxation 1.1 The Optimum Supply of Public Goods 1.1.1. The Pure Theory of Public Expenditures

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1. The Benefit Principle of Taxation 1.1 The Optimum Supply of Public Goods

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  1. LECTURE “TAXATION ECONOMICS”AT STATE UNIVERSITY –HIGHER SCHOOL OF ECONOMICS by Professor Dr. Christian SEIDL,University of Kiel, Germany

  2. 1. The Benefit Principle of Taxation 1.1 The Optimum Supply of Public Goods 1.1.1. The Pure Theory of Public Expenditures 1.1.2 Public Goods with Free Disposal 1.1.3 Improper Public Goods 1.1.4 Public Goods as Inputs 1.1.5 Private Supply of Public Goods 1.1.6 Financing the Supply of Public Goods by Distorting Taxation

  3. 1.2 Allocation Mechanisms of Public Goods 1.2.1 Problems of Devising an Allocation Mechanism 1.2.2 Implementing an Allocation Mechanism in Dominant Strategies 1.2.3 The Clarke-Groves Mechanism 1.2.3 The Groves-Ledyard Mechanism 1.3 Literature

  4. 2. The Ability-to-Pay Principle of Taxation 2.1 First Best Taxation 2.1.1 Taxing Income or Expenditure? 2.1.2 The Equal-Sacrifice Principles of Taxation 2.2 Second Best Taxation 2.2.1 Deadweight Loss of Taxation 2.2.2 Optimum Commodity Taxation 2.2.3 Optimum Income Taxation (Asymmetric Information) 2.3 Literature

  5. 3. Tax Compliance 3.1 Tax Avoidance 3.2 Tax Evasion 3.3 Corruption and Extortion 3.4 Literature 4. Tax Progression 4.1 Measures of Tax Progression According to Tax Schedules 4.2 Aggregate Measures of Tax Progression 4.3 Single Crossing Conditions 4.4 Measurement of Tax Progression with Nonconstant Income Distributions 4.5 Literature

  6. 5. Tax Reform in Practice 5.1 Micro-Simulation of Tax Reform 5.2 Flat Tax Reform: The Case of Germany 5.3 Literature

  7. PRINCIPLES OF TAXATION How should a tax be determined? • According to a citizen’s (marginal) valuation of the goods and services provided by the public authorities. This is the benefit principle oftaxation. • According to a citizen’s ability to pay for the goods and services provided by the public authorities. This is the ability-to-pay principle of taxation.

  8. 1. The Benefit Principle of Taxation 1.1 The Optimum Supply of Public Goods 1.1.1. The Pure Theory of Public Expenditures 1.1.2 Public Goods with Free Disposal 1.1.3 Improper Public Goods 1.1.4 Public Goods as Inputs 1.1.5 Private Supply of Public Goods 1.1.6 Financing the Supply of Public Goods by Distorting Taxation

  9. 1.1.1. The Pure Theory of Public Expenditures • In 1993 I visited Professor Richard A. Musgrave in Santa Cruz / California [where he had retired from Harvard]. • He told me the story of how Paul A. Samuelson came to develop his famous pure theory of public expenditures. • In the second half of the 19th century scholars like E. Sax, M. Pantaleoni, U. Mazzola, A. de Viti de Marco [later also K. Wicksell and E. Lindahl] proposed to extend the application of marginal utility theory [which had been developed by Menger, Gossen and Jevons] from the supply of private goods also to the supply of public goods. • Having studied in Germany until 1933, he was aware of this theory, and, in 1938, published an article entitled “The Voluntary Exchange Theory of Public Economy” in the Quarterly Journal of Economics. This article had induced Samuelson to develop his pure theory of public expenditures 16 years later. • [It should be mentioned that the benefit principle of taxation had earlier also be invoked by J.St. Mill, J. Locke, and other writers; see Seligman 1908.]

  10. The Properties of Public Goods

  11. Two examples of pure private goods: what one eats, cannot be eaten by the other at the same time. Friedrich Herlin, Altar of St. James, Rothenburg o.d. Tauber, Germany, 1466. An American couple in a Viennese restaurant in 2001.

  12. A pure public good: The Pharos of Alexandria [one of the Seven Wonders of the World], built in 299 BC, height 120 to 140 meters; broke down in 796 AD because of an earthquake.

  13. Nonrivalry in consumption: a public good where the exclusion principle applies.

  14. ℓ denotes the number of commodities

  15. which is the Samuelson condition of the Pareto-optimal supply of private and public goods. Recall that the optimum condition for the supply of private goods alone is:

  16. 1.1.2 Public Goods with Free Disposal

  17. 1.1.3 Improper Public Goods

  18. (3.2)

  19. (3.2) (3.1)

  20. 1.1.4 Public Goods as Inputs

  21. 1.1.5 Private Supply of Public Goods

  22. (3.10)

  23. 1.1.6 Financing the Supply of Public Goods by Distorting Taxation In Section 1.1.1 we derived optimality conditions which require neutral taxes (lump-sum different income distributions and different preferences. This allows us to concentrate on the excess burden of taxation inflicted upon a representative consumer. Furthermore, we restrict ourselves to indirect taxes, i.e,, proportional taxes on commodities inclusive of labor force, and examine those changes in the Samuelson condition which arise from the necessity to apply distortive taxation to finance the supply of public goods.

  24. (3.13)

  25. Hence,  0 and 

  26. (possibly)

  27. 1.2 Allocation Mechanisms of Public Goods 1.2.1 The Simple Geometry of an Allocation Mechanism 1.2.2 Problems of Devising an Allocation Mechanism 1.2.3 Some Examples of Allocation Mechanisms 1.2.4 Implementing an Allocation Mechanism in Dominant Strategies 1.2.5 The Clarke-Groves Mechanism 1.2.6 The Groves-Ledyard Mechanism

  28. 1.2.1 The Simple Geometry of an Allocation Mechanism • Recall that we discussed two properties of public goods: • Non-exclusion in consumption • Non-rivalness in consumption • When exclusion in consumption applies, the supply of public goods may occur along the lines of the supply of private goods: (S)he who does not pay for the consumption of the public good is excluded from its consumption. This threat induces consumers to reveal their true preferences for the public good in terms of marginal preparedness to pay. • In Section 2.1 we needed only non-rivalness in consumption. Let us now assume that, in addition, the exclusion principle does not apply. • Before analyzing this situation let us cast a look at the taxonomy of the joint operation of the applicability of the exclusion principle and rivalness in consumption.

  29. Examples of different good categories Rival in consumption yes no Does the exclusion principle apply ? no yes

  30. The presence of a free rider problem means that a public good which might have rather high value for the community is either not supplied at all, or only in a suboptimal amount: this means marked failure. (Example: too small swimming pool for a community.) True Revelation of Preferences • The power of the exclusion principle. (S)he who does not demand goods according to his or her preferences hurts himself or herself. • Failure of the applicability of the exclusion principle invalidates the punishment for the revelation of false preferences. This means that the respective good can be consumed by agents who have nothing contributed to its supply: this is the free rider problem. It was first pointed out by Wicksell (1896, p. 100).

  31. An example of free riding (with private goods where the exclusion principle does not apply). “The neighbors are on vacation!”

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