Public Finance, 3rd Edition

The Measurement of Loss from Distorting Taxes

The first question of distorting taxation concerns the measurement of welfare loss: Relative to the first-best optimum, what is the social welfare loss resulting from any given pattern of distorting taxes, within the context of a one-consumer, linear production economy? With one consumer, loss in social welfare is equivalent to the consumer's loss in utility. To be concrete, assume that the distorting taxes (transfers) take the form of unit taxes on both the consumer's purchases of goods and services and his supply of factors, levied on the consumers. In principle, then, the taxes include most forms of sales and excise taxes on the product side and income taxes on the factor side. In practice, only ...