The Welfare Economics of Taxes: a Three-Class Disposable Income Growth Model

Abstract

This article presents an alternative approach to the welfare economics of taxes, and to the choice between an income, wage, and consumption tax. In contrast to standard efficiency analysis of taxes, and to much of the optimal growth literature, the central focus is on the welfare of different classes under alternative taxes in a multiclass growth model when redistributive transfers are excluded as unfeasible. When tax rates are set to achieve the same steady-state tax revenue per effective labor and equal progressivity in a three-class disposable income growth model, an income tax always achieves a lower welfare for the low-skilled labor class than either a wage or consumption tax due to the "horizontal redistribution effect. "It is also shown that it is possible for a citizen to sensibly prefer a tax that achieves a capital-intensity in excess of the golden rule level; and for a tax switch that maintains progressivity and raises capital-intensity to benefit low-skilled workers in the short as well as long run.