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Consumption Versus Income Taxation: Three Moments in the Political Economy of Fiscal Choice

PFM, Vol. 9 No. 3, (2009)

Most modern economies tax both consumption and labour income. While there is an extensive normative literature on the optimal mix of the two taxes, there is little examination of what determines the actual mix in a well specified political economy context. We use a multi-dimensional spatial voting framework to simulate endogenous political tax equilibria. The model accommodates complex interactions between many of the first three moments (mean, variance and skewness) of three distributions identified in the literature as crucial: the distribution of income, of preferences for public goods and the distribution of political influence. To simplify, we focus on a balanced and an asymmetric society and analyze how different combinations of distributional moments interact in the determination of tax equilibria. Interesting links emerge between the nature of the distribution of preferences for public expenditure, income inequality and the relative importance of consumption taxation. The analysis suggests that studies of single taxes have limited relevance for the explanation of the observed tax mix.

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