The Ramsey Rule Reconsidered

Abstract

The Ramsey rule for optimal excise taxation suggests that goods should be taxed in inverse proportion to their elasticities of demand. This analysis shows that when the political process that determines tax rates is taken into account, the Ramsey rule may not be superior to a fiscal constitution that specifies that all goods are taxed at the same rate. The information necessary to set taxes in conformance with the Ramsey rule is not directly observable, which will lead to rent-seeking activities as interest groups try to influence the political determination of tax rates they face. Furthermore, incentives in the political process work against setting taxes according to the Ramsey rule. Building on Buchanan’s work on optimal taxation and the nature of the fiscal constitution, the Ramsey rule should be reconsidered as a guide to optimal excise tax policy.