Production Efficiency in Tax-Distorted Economies with Multiple Revenue
Constraints
by
David E. Wildasin Martin School of Public Policy and Department of Economics University of Kentucky Lexington, KY 40506-0027 USA
Abstract
This paper examines the problem of optimal taxation in an economy with
multiple units of government, each with its own budget constraint,
such as a federation with many subnational governments or the world
economy. The Diamond-Mirrlees production efficiency condition is
satisfied under an optimal tax structure when a higher-level
government can make optimal lump-sum interjurisdictional transfers, or
when the number of traded goods exceeds the number of jurisdictions.
In either of these cases, appropriate policies (transfers or optimal
tariffs/subsidies on traded goods) equalize the shadow value of public
funds among governments. Otherwise, however, it may be optimal to
introduce tariffs/subsidies on traded goods that prevent the
attainment of system-wide production efficiency.
