constant marginal util under the equal F'N1amount sucI

Inthe third
phase,
while tax-payer R will
marginal
pay suffered by the two taX-payers is
sacrifice for both the taxpayers (FNMG +
equalsames Paythe
the or
FN amount
required revenue
equal
T. The whilethe total
FlG'
because FG = incomes are
minimised. Thus
sacrifice
equalised at OF and
O'F' for both and R
P
FNMG
is
respectively.
OPTIMAL TAXATION discussing the various principles/theories
of this
of taxation.
after optimal. The answer question can be
burning question arisestheory is the taxation.
A which principle or criteria of optimal
It is that define the
provided when we following objects are related :criterion of optimality
In thisregard,cost of Resources. The foremost
maytaxbe
() Minimum
minimizing its resource cost. It should
but
be remembered that a
also a resource cost to the
also
conceived
system not
in terms of
Uniortunately, the
collection to the authorities
ignored by
only entails cost of cost to the tax-payers is usually tax-payers in terms of
to the
the
tax-payers.
authorities
while
and
alternative tax measures. Even cost that in terms of time and effo is often
deciding on account,
sometimes taken into
other resources is
ignored. second criterion may be some kind of a me
measure of justice of

(ii) Justice of Equity. The place of various principles of

context the taxation
already discussed inthis
equity. We have thinkers ability-to-pay, cost-of-service, and benefits-recoi
propounded by such as the
conclude that the economists lack a general agreement in this field.
IWe can ceriterion can be derived in terms of some measura
(iii) Economic Efficiency. The third
economic efficiency. Such acriterion however admits a wide field over which to onerat
of way in which the concept of efficiency is
and quite a good deal will depend upon the distortions in resources
defined. Thus, for instance, we may confine ourselves only to thesystem. The main idea is
allocation or it may include some other inmplications of the tax
that tax system should lead to the minimum possible deadweight to the system as a whole.
The concept of optimal taxation criteria is based on three decisions as stated below:
(a) the aggregate amount of taxation and its division between direct and indirect
taxation ;
(b) the composition and rate schedules of direct taxes; and
(c) the composition and rate schedules of indirect taxation.
Allthese three decisions are interdependent but it gives important complication. This
complication arises on account of the fact that a modern government has non-tax means
of procuring budgetary resources such as market borrowing, resorting to the printing
press and income from public sector undertakings.Thus there is no general value to decide
this criterion.
As regards the commodity taxation, the economists usually
of its resource allocation effect. They choose a particular consider it in the conte
resource allocation as the moSt
 ANDTHEORYY OF TAXATION
TANATION
one
etticient
and consider deviations therefrom as the cost to the 149
that which conforms to the
alocationis possibleto shift Paretian type. AParctianeconomy. One such resoucc
and incrèasce
i tis not
i t along some other line. This efficiency of resource useoptimality
along onewould
line indicate
that
rducing
dditionin efficiency
may exceed resource
the reduction in optimality
it ignores without
the possibility that
solution to the through such a shift. Leaving asidethe
Paretianoptimality, one optimal
that a lump sum tax does not affect taxation
is that of
either the marginalimposing lump sum taxes.
cost of production
argueumarginal
income
utility of purchases to the consumers.
effect, the marginal utilities are bound to be However, since every tax has
to the
an utility schedules of commodities differ
from each altered particularly because the
marginal
notenable us to decide the way in which tax liability should be other. Further, this amongst tax-
distributed
reasoning does
Anyddecision will1 have its distributive and
payers. resource allocation via
etfectson demand for goodswelfare
and repercussions also and the actual
other things, on demand elasticities for final consumptionservices
goods. would depend, amongst
on profits is consistent with Paretian
optimality. Such a tax, it is claimed, is
to production and investment decisions. But it ignores
neutral with respect the
possibility
ofa depressing effect on capital formation. When income earners find that income from
profitshasfallen, their perference moves in favour of current consumption at the cost of
savingsand investment which in turn slows down the rate of economic growth. During
the course of discussing tax optimality we should keep in view the growth efficiency with
operational efficiency ofthe economy. This question is also debatable whether the authorities
n raise allthe needed tax revenue from 'neutral' taxes alone. Any tax which tries to touch
all or alarge number of incomes willhave to be based upon a large number of considerations
like income elasticities of goods and services. The problem defies a satisfactory and practical
solution especially in the dynamicset up. The problem becomes stillmore acute when we
introduce the possibility of various direct taxes other than the one on income.
Considering the indirect taxation, Paretian optimality cannot be taken as the ideal one,
at least on two grounds. Paretian optimality ignores the wide-spread existence of
estrernalities and the possibilities of accelerating the pace of economic growth through a
shift in the rate of saving and in investment pattern.
Therefore, uniform taxation of all goods at equal percentage rates would amount to
raising the same tax revenue on alump sum basis since have all tax-payers find a proportionate
reduction in their incomes. Accordingly this tax should no resource allocation effects.
unrealisticassumptions. It is assumed,
Such a conclusion, however, requires some strong and has the same elasticity with respect
for example, that demand for all consumption goods
Alternatively, if a variation in demand elasticities is allowed for,
to all income earners. uniform rates.
Commodities cannot be taxed at
question relating to externalities was effectively emphasised
We are alsofamiliar that the
Finance. Once the existence of externalities is admitted, acase
Dy Pigou in his Study in Public gains credence. Public goods are known to possess
TOr non-uniform commodity taxation and anon-uniform taxation becomes very relevant in their
CAternalities in a wide measure benefit. In
equality between marginal social cost with marginal socialdiscussion of
abe tor bringing an measures are very difficult to estimate. In the need tax
uce, however, marginal externalities, it is assumed that the state does not
yng taxes to counteract welfare state, Govt. has to meet its ever increasing expenditure
allocation.
evenue for its own sake In a distort (rather than improve) resource two types
taxes which of these
Thsto impose even those working out an optimal combination
POints towards the need for
of taxes.9 efficiency
optimal taxation, it is said that welfare and and equity
discussion of efficiency
0 conclude the be top priority. Again, trade off betweenfrom serious weakneses.
aspect of taxation must given maintained, though it also suffers
Eectives of taxation should bemore near reality.
GVen then, this view point is

9 Taxation in the Presence of Externalities."

ngnar Sandmo. Optimal