EC325 LT Knowledge

Question 1

What is the Ramsey Rule?

Answer 1

The marginal DWL per dollar of tax revenue must be the same for all commodities.

Question 2

What are the 3 stylized facts about tax and development?

Answer 2

1. The positive relationship between tax take and development across countries is driven entirely by modern third-party reported taxes
2. The evolution of tax take over the course of development within countries follows an S-shaped pattern driven by the expansion modern third-party reported taxes
3. The tax take is positively related to firm size and negatively related to self-employment within and across countries.

Question 3

How to explain the rise of tax as a proportion of GDP?

Answer 3

1. Demand for public goods has an income elasticity above 1, so when income grows, people demand a greater proportion of public goods
2. Stagnating productivity in the public sector
3. Ratchet effect whereby temporary shocks (such as wars) raise government expenditure, which do not fall back after the shock
4. Political economy aspects
   
   1. Tax enforcement improves over the growth path due to the rise of modern formal firms. (3rd party information provision)

Question 4

Limitations of Value-Added tax?

Answer 4

1. Collusion between buyers and sellers throughout the supply chain can prevent transmission of information
2. Small firms are often exempt from VAT due to the compliance and administrative costs: incentivizing firms to stay small and not grow
3. Last mile problem: Customers do not provide information on retailer revenues