SFB 303 Discussion Paper No. A - 574

Author: Gaube, Thomas
Title: When do distortionary taxes reduce the optimal supply of public goods?
Abstract: It is often argued that the optimal level of public good provision is below the first-best level as long as the government's expenditures have to be financed by distortionary taxes. We examine this hypothesis and show that it is correct if (i) the public good is normal and (ii) all groups of private commodities taxed at different rates are normal and gross substitutes. However, if the gross substitutes assumption is not fulfilled, the conjecture may fail even if the economy is otherwise well behaved. The results hold irrespective of the heterogeneity of households as long as the second-best allocation is distributionally optimal.
Keywords: Pigou's conjecture, public goods, optimal taxation
JEL-Classification-Number: H41, H21
Creation-Date: April 1998
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