NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Direct or Indirect Tax Instruments for Redistribution: Short-run versus Long-run

Emmanuel Saez

NBER Working Paper No. 8833
Issued in March 2002
NBER Program(s):   PE

Optimal tax theory has shown that, under weak assumptions, indirect taxation such as production subsidies, tariffs, or differentiated commodity taxation, are sub-optimal and that redistribution should be achieved solely with the direct income tax. However, these important results of optimal tax theory, namely production efficiency and uniform commodity taxation under non-linear income taxation, have been shown to break down when labor taxation is based on income only and when there is imperfect substitution of labor types in the production function. These results in favor of indirect tax instruments are valid in the short-run when skills are exogenous and individuals cannot move from occupation to occupation. In the long-run, it is more realistic to assume that individuals choose their occupation based on the relative after-tax rewards. This paper shows that, in that context, production efficiency and the uniform commodity tax result are restored. Therefore, in a long-run context, direct income taxation should be preferred to indirect tax instruments to raise revenue and achieve redistribution.

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Document Object Identifier (DOI): 10.3386/w8833

Published: Saez, Emmanuel. "Direct Or Indirect Tax Instruments For Redistribution: Short-Run Versus Long-Run," Journal of Public Economics, 2004, v88(3-4,Mar), 507-518. citation courtesy of

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