SFB 303 Discussion Paper No. A - 054

Author: Tillmann, Georg
Title: Taxation and Observability
Abstract: One of the most fundamental issues in welfare economics is the problem of redistribution. "Poor people" are favoured and "rich ones" taxed by certain ethical reasons. There may be many tools to change the income distribution but one of the most fundamental ones is an income tax or more generally, taxes. Normally, a special social welfare function (SWF) which represents the redistributive aims of the government is maximized. In most of these models we have a continuum of consumers. In every tax-problem there is a two-step maximisation: First agents maximize their utility - given a special tax function T; second, the government seeks the optimal tax according to its aims. This is normally done using calculus and especially first order conditions. But it is well known that these conditions characterize only a local solution - apart from the fact that it is not even known if they determine a maximum at all. The discrete approach avoids these difficulties and provides us with a different perspective on how the problem works. Additionally, it makes more explicit the interaction between the government which is the planner and the agents who are the consumers. Therefore we have a special principal- agent problem, where incentives play an important role.
In our paper we will do the following: As the weakness of SWF's is well known we use the Pareto-criterion only and ask ourselves: Which optima can be implemented if the planner observes l (number of hours worked), y (income) or (y,l) together? Which "signal" s is "better"? Here better means that the set of implementable optima with respect to si contains the set of optima with respect to sj. At first this will be done in finite economies. We then go over to "large economies" with a continuum of agents. Which optima do "survive" in this case? This is examined in a second part. All proofs are given in part three.
Creation-Date: 1986
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