Generalized Production Efficiency

• In Event: Optimal Capital and Firm Taxation

Abstract

When should governments sacrifice production efficiency for redistribution? We generalize the celebrated result of Diamond & Mirlees (1971) by allowing for imperfect competition, suboptimal and nonlinear taxation. We demonstrate that production efficiency hinges on the flexibility of the tax system in compensating gains and losses from changes in factor prices. This requires the tax system to target each factor's income. We show how to adjust tax systems or production policies for imperfect targeting and market failures, even when the tax system is not flexible enough. We then obtain new sufficient statistics formulas. Endogenous factor prices do not modify the test to identify Pareto-improving tax reforms.

Authors

• Laurence Jacquet, CY Cergy Paris Université, ThEMA

• Etienne Lehmann, University Paris II