Income Taxation, Commodity

Taxation and Provision of Public

Goods under Labor Market
Distortions

Authors: Thomas Aronsson and Tomas Sjögren

 INTRODUCTION
● How governments can make the best optimal tax and public service
decisions in places where the job market isn't perfect.
● Uses a mix of different tax methods combining nonlinear income tax
with linear commodity taxes
● Works by Atkinson, Stiglitz, and Mirrlees in the 1970s
● Wealthy people should not face high taxes
● Others studied how to give people public services when taxes are
complicated
● This paper looks at places where there aren't many jobs and where
unions have more say in wages.
● The paper uses ideas from Stern and Stiglitz's work
CONSUMERS
 THE LABOR MARKET
● How the job market works when a country mainly imports most goods and uses
money from exports to pay for them.
● 2 types of workers: Skilled and unskilled workers
● Government has the power to change things
● These things affect how much power unions have in setting wages and how
many jobs are available.
● Figuring out the best ways for the government to handle these issues is crucial
for making sure everyone benefits as much as possible.
 PARETO EFFICIENT POLICY
● Previous studies as conducted by Boadway and Keen (1993) and Edwards et al.
(1994), the optimization problem was written in such a manner that B i and yi are
decision variables facing the government.
● However, the authors find it more convenient to use l i instead of yi as a decision
variable.
● The government must opt for its decision variables, B 1, B2 ,Bun, l1, l2, G and p.
● For type 2 individuals to have the same income as type 1, they must determine their
labor input such that:
The self-selection constraint of the high-ability type can be written as:

The self-selection constraint was only for high-ability type individuals, not for low-ability
type individuals. REASON?
One more additional constraint that the government often tends to face, as mentioned
by the authors in the paper was the Budget Constraint.

● The role of the Government is to generate tax revenue through Labor Income Tax
and also through Commodity Taxes.
● The revenue generated from these taxes is generally utilized to support public
services and welfare programs such as unemployment benefits.
● The Budget Constraint of the Government takes the form:
 COMMODITY TAXATION

1. It is paramount for the government to understand how

commodity tax affects the wage ratio.
2. If higher commodity taxation increases employment,
then there is additional gain associated with commodity
taxation and vice- versa.
 This study examines the complex relationship between various
tax policies and the effects they have on the economy, especially
when there is a labor market distortion. More precisely, the
study examines the impact of commodities taxes in this setting.
1. Labor Market Distortions and Commodity Taxation
2. Welfare Effects
3. Optimal Tax Design
4. Revenue Generation
5. Interaction with Income Taxation
 CONCLUSION
1. Optimal commodity taxation should be used to correct for consumption externalities, in
addition to the standard income tax.
2. When there are labor market distortions, the optimal commodity tax structure should also
account for how the taxes affect labor supply incentives.
3. The optimal provision of public goods should balance the marginal benefit of the public
good against the marginal cost, where the marginal cost accounts for the distortionary
costs of raising tax revenue (the marginal cost of public funds)
4. In a nutshell, in the presence of externalities and labor market distortions, the optimal tax
system involves an interplay of non-linear income taxation and linear commodity taxation,
with the commodity tax rates designed to correct for both externalities and labor supply
incentives.