Tax revenue is required to fund the provision of public goods and other government services, as well as for redistribution from rich to poor individuals.
[2] The optimization problem involves minimizing the distortions caused by taxation, while achieving desired levels of redistribution and revenue.
[5] In the Wealth of Nations, Adam Smith observed that Generating a sufficient amount of revenue to finance government is arguably the most important purpose of the tax system.
Note that it does not matter which side actually writes the government's check, the market price will adjust to compensate (see Tax incidence).
However, if both supply and demand are elastic—producers will make less at a lower price and consumers will buy less at a higher price—then the equilibrium quantity will decrease.
There may be a consumer willing to buy at a price for which a producer is willing to sell, but this Pareto optimal transaction does not occur because neither is willing to pay the government's cut.
While that question has no definitive answer, tax policy must balance competing goals such as revenue raising, redistribution, and efficiency.
Feldstein recognizes that high taxes deter people from actively engaging in the market, causing a lower production rate as well as a deadweight loss.
Any gain in economic efficiency from shifting taxes to consumption may be quite small, while the adverse effects on income distribution may be large.
Lump-sum taxes are also unpopular when they are assessed per capita because they are regressive and make no allowance for a citizen's ability to pay.
He was the first to make a significant contribution to the theory of optimal taxation from an economic standpoint, and much of the literature that has followed reflects Ramsey's initial observations.
He wanted to confront the problem of how to adjust consumption tax rates, under specified constraints, so that the reduction of utility is at a minimum.
They rely on what has been labeled the revelation principle where planners must implement a tax system that provides proper incentives for people to reveal their true wage-earning abilities.
[16] They examine the proposition that in order to reach the optimal point of allocating resources, prices that deviate from marginal cost are required.
They conclude that under constraints, the best possible theory to get close to optimality, which is not “best” at all, is the systematic division between prices and marginal costs.
Mankiw argues that Diamond's and Mirrlees's theory is extremely complex because of how difficult it is to keep track of individuals producing at their maximum levels.
They include, first, the idea considering horizontal and vertical equity, that social planners should base optimal tax schedules on income rates for labour, which marks the equality and efficiency trade-off.
Second, the more income an individual makes, their marginal tax schedule could actually decrease because they are discouraged from working at their optimal production level.
Fourth, the increase in wage inequality is directly proportionate to the extent of income redistribution as revenue is distributed to low-income earners.
Slemrod advocates this theory because not only does it take into account the preferences of individuals, but also the technology involved in tax collecting.
As referred previously, taxes have the purpose of fixing economic disparities among individuals, and that assortment of living standards and income generates competitiveness, especially among countries.
The globalisation process has created new rules for companies and citizens to move across borders and, therefore, the tax systems they shall oblige to.
Consequently, countries compete with each other on the taxation programme offered to both singular individuals and corporations, with the aim of becoming attractive to foreign agents, and simultaneously breed tax revenues to fund the government’s budget.
[22] It may sound somewhat paradoxical, but the change in the tax rates makes individuals more aware of the tariffs that are practised in other countries, contributing then for the globalisation.
Feldstein argues that one of Harberger's shortcomings is that policy makers typically focused on the effects on personal income tax.
[9] William Fox and LeAnn Luna proposed another theory in a joint article “State Corporate Tax Revenue Trends: Causes and Possible Solutions", in which they take on the role of this taxation.
Conversely, the effective tax rate on marginal projects (with returns closer to the "normal" level) will be reduced.
[26] In this article, they look at how personal state revenues and sales tax bases elasticities change for the short and long term in an attempt to determine the difference between them.
Taxation of capital in any form: above all financial instruments, assets then property was proposed as most optimal by Thomas Piketty.
Political economist and social reformer Henry George most notably championed the idea of a land value tax in Progress and Poverty, as a levy on the value of unimproved or natural aspects of the land, primarily location; it disregards the improvements such as buildings and irrigation.