Scribd
Upload
554 views9 pages

Optimal Taxation

This document discusses the Ramsey Rule for optimal taxation. The Ramsey Rule states that tax rates should be inversely related to the elasticity of demand for goods - goods with less responsive or elastic demand can be taxed at higher rates with less deadweight loss. While taxing necessities with inelastic demand leads to smaller deadweight loss according to the Ramsey Rule, it may also result in a regressive tax system since necessities represent a larger share of income for poorer households. The Ramsey Rule also does not consider administrative and compliance costs of taxation.

Uploaded by

Teena George
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
554 views9 pages

Optimal Taxation

This document discusses the Ramsey Rule for optimal taxation. The Ramsey Rule states that tax rates should be inversely related to the elasticity of demand for goods - goods with less responsive or elastic demand can be taxed at higher rates with less deadweight loss. While taxing necessities with inelastic demand leads to smaller deadweight loss according to the Ramsey Rule, it may also result in a regressive tax system since necessities represent a larger share of income for poorer households. The Ramsey Rule also does not consider administrative and compliance costs of taxation.

Uploaded by

Teena George
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd

Theory of Optimal

Taxation. Ramsey Rule


Introduction
The optimal design of a tax system is a topic that has long fascinated
economic theorists and flummoxed economic policymakers. This paper
explores the interplay between tax theory and tax policy. It identifies key
lessons policymakers might take from the academic literature on how
taxes ought to be designed, and it discusses the extent to which these
lessons are reflected in actual tax policy.

Presentation title 2
Ramsey Rule
As demonstrated in the prior readings, the imposition of taxes by the government can
lead to a decrease in overall welfare. As shown in the section on excess burden, $1 of
taxation may cost society more than $1 due to the changes in behavior resulting from
the possible reduction in price received by the supplier, and the possible increase in
price received by the buyer. As shown in Figure 1, when a tax is imposed on a good, the
consumer will most likely pay a higher price for that item and the seller will most likely
receive a lower price. The incidence, or the individual/entity paying the tax, ultimately
depends on the elasticity of supply and the elasticity of demand—that is, the
responsiveness of supply and demand to changes in prices. Additionally, the size of the
dead weight loss to society also depends on the elasticity of supply and demand.

Presentation title 3
Figure 1: Supply and Demand
Responses to the Imposition of a Tax

Presentation title 4
The Ramsey Rule
F.P. Ramsey used this model as a starting point for considering what sort of
taxes might have the least distortionary, welfare-reducing effect on society. For
simplicity’s sake, Ramsey assumed a case of perfectly elastic supply, where a
supplier will provide an infinite amount at a given price. In this model, as seen
below, the more inelastic the demand, the less the dead weight loss. Thus, when
demand is less responsive to changes in prices, then the imposition of a tax
results in a smaller dead weight loss. According to this argument, politicians
will generate a smaller cost to society if they tax necessities such as milk, which
people will continue to buy in the face of an increase in prices. A simplified
version of the Ramsey rule is the “inverse-elasticity rule.” This rules states that
tax rates on goods should be inversely related to their elasticity of demand

Presentation title 5
A. More Elastic Demand

Presentation title 6
Argument against the use of the Ramsey Rule for Taxation
The major criticism of the Ramsey rule is based on the observation that the
demand for necessities is more inelastic than the demand for luxuries. As a
result, a tax system that strictly follows the Ramsey rule might be somewhat
regressive in nature, because necessity goods are likely to represent a higher
percentage of household income for poorer households. Many have also
criticized the rule because the application of this rule will likely result in
important administrative and compliance costs.

Presentation title 7
Bibliography
• [Link]

Presentation title 8
Thank you

You might also like