On the Direct Versus Indirect Taxation Controversy

Abstract

the well-known Atkinson and Stiglitz (1976, section 5) theorem on the superiority of nonlinear direct taxation over nonlinear indirect taxation is proved to hold under the second order approach, even on intervals where the monotonicity constraint is binding. this confirms for the nonlinear case previous findings by Kaplow (2006) and Laroque (2005), who considered a joint combination of linear indirect taxes and, possibly suboptimal, nonlinear income taxation. the intuition behind is that, when indirect taxation is not restricted to linearity, its elimination is only justified if the income taxation scheme becomes optimally chosen, as happens in Atkinson and Stiglitz (1976). In addition, our analysis allows for a more general class of sub-utility functions than the one in the Atkinson and Stiglitz theorem, which includes work done or income further to consumption goods and services. Finally, the possibility that optimal llocations fail to be differentiable, or continuous, is also contemplated unlike in the standard literatura.