THE THEORY OF OPTIMAL INDIRECT TAXATION: A SURVEY ARTICLE

Abstract

This paper is a survey of recent development in the theory of optimal indirect taxation in connection to the so-called second best problem. We have already had a clear introduction to the literature provided by Sandmo [69]. The major concern with it, however, is limited to the efficiency aspect neglecting rather the distributional aspect associated with the optimal taxation. Moreover, after his survey, a number of the important contributions appeared in the current field. Motivated by the fact, the purpose in this paper is twofold. The first is to give a systematic and unified treatment which might help the reader understand easier the essence of the optimal taxation problem. The second is to explore the economic implications of optimal tax rules putting emphasis on the trade-off relationship between efficiency and equity.
The paper is organised as follows. In section 2, the basic structure of the optimal indirect taxation is reformulated in a broader framework and preliminary considerations are provided for interpreting the optimal taxation conditions. In section 3, the economic implications of optimal tax rules are explored relative to the range of instruments assumed to be available to the government and emphasis is placed on the fact that optimal commodity tax rules have a variety of its meaning depending on the supplementary tax instruments. In section 4, the developing topics related to the optimal taxation are briefly summarised and the further research areas are suggested. The major topics are: (i) the theoretical integration of optimal income tax, (ii) the basic analytical problem such as existence and so on, (iii) the extension of the framework, and (iv) the tax reform theory.