Abstract

This paper will cover an overview of Optimal Tax Theory with a special emphasis on the benefits and drawbacks of a Lump Sum Tax. Covering the work of Ramsey (1927), Mirrlees and Diamond (1971a, b), Slemrod and Yitzhaki (1996), Samuelson (1954), Lindahl (1919, 1958) and others, the paper compares and contrasts the foundational works in Optimal Tax Theory on a Lump Sum Tax with more recent literature. The purpose of this analysis is to shine new light on how a Lump Sum Tax might be better implemented in the future. Also considered are to how to maximize efficiency in a tax scheme while minimizing the political unpopularity of such an unequitable tax, in particular how a Lump Sum Tax ushered in the end of Margaret Thatcher’s political career. While the ultimate goal of any tax-collecting agency is to tax ability, this is not possibile since high-ability, and hence, high-income, earners will attempt to disguise themselves as low-ability (low-income) to minimize their tax burden. Using the Ramsey Rule (1927) and Slemrod and Yitzhaki’s (1996) “marginal efficiency cost of funds”, I compare the Lump Sum Tax to other taxation schemes, such as a progressive tax, which is generally seen to be more equitable to those who are concerned with social justice, and a regressive tax, which is generally seen to be more efficient to those who are concerned with minimizing their tax burden. Also considered are efficiency concerns regarding enforcement and the costs associated with enforcement of these other tax schemes; a LST would dramatically reduce enforcement costs and the confusion that comes with calculating progressive tax brackets. I argue that it is not enough to consider the impact and efficiency of such a tax, but that the political ramifications must also be considered; due to social welfare concerns, such a tax must also be politically feasible in order to be successful. This paper will be of benefit to anyone who is interested in making the current U.S. tax regime more efficient while addressing equity concerns in its implementation, citing historical examples including the U.K., Italy, Romania, and Switzerland.

Keywords: Optimal Tax Theory, Lump Sum Tax, efficient tax, equity, social welfare, marginal efficiency of funds.

JEL Classification: D60, H21, H22, H71.

Cite as: Richard Fast. (2021). Examining A Lump Sum Tax and Optimal Tax Theory. SocioEconomic Challenges, 5(4), 166-171. https://doi.org/10.21272/sec.5(4).166-171.2021

This work is licensed under a Creative Commons Attribution 4.0 International License

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