Any given tax system at any one time is unlikely to be optimal in the sense defined in the previous three chapters. It is also extremely unlikely that it would be politically and administratively feasible to replace an existing tax system with an optimal one, even if we knew with any degree of quantitative precision what it looked like. From the point of view of practical tax policy, therefore, the question of tax reform, the implementation of small, piecemeal changes to an existing tax system, is the most relevant one. In this chapter, we adopt the approach of tax reform to analyse the effects of tax policy in an economy consisting of two-person households with household production. We take account of the effects of tax reform on the within-household distribution of utilities, exploiting in doing so the idea of the household as a small economy, but our main concern, as in the previous chapters on optimal taxation, is with the effects on the across-household distribution and their implications for the tax structure.
The public economics literature on the theory of tax reform looks forbiddingly technical. We believe, however, that the main general points of this literature can be made simply and non-technically. The formal analysis is only required when we begin to look at specific tax reform policies, as we do in the remainder of this chapter.
To begin with, we should take account of two traditional warnings on the possibility of misleading intuition when we are in the second-best world of piecemeal policy reform.