Political Incentives and Optimal Taxation

Abstract

Recent studies have questioned the empirical relevance and normative validity of the traditional prescriptions for optimal taxation based on Ramsey's original in sights. The present authors analyze governments that maximize net political benefits, which only imperfectly represent net social benefits, and conclude that Ramsey's rules always yield empirically relevant predictions once they are modified to account for existing restraints on taxation. Moreover, for a broad spectrum of governments, an unrestricted tax base is socially optimal, and Ramsey's rules apply without modification as valid normative prescriptions. However, restraints on taxation are optimal for governments that create more than a critical level of distortion in evaluating the marginal social costs and benefits of taxation and spending. None theless, Ramsey's rules still provide valid normative prescriptions once the optimal constitutional prescriptions are imposed.