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Welfare and Direct Taxation*

Published online by Cambridge University Press:  07 November 2014

Anthony Y. C. Koo
Anthony Y. C. Koo*
Affiliation:
Michigan State College
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Extract

Discussion of the issue of the welfare effects of direct, as compared with indirect, taxes have been greatly clarified by the recent contributions of Mr. Little and Professor Friedman. Both of them show that the usual method of using indifference curves to prove the superiority of income tax over sales tax makes “no overt reference to marginal costs. Yet it is well known that nothing can be proved without some such reference.” They employ an alternative mode of analysis which is designed to take account of conditions of cost of production.

Before the appearance of their articles, Professor Boulding showed the comparative welfare effects of proportional, progressive, and regressive income taxes by the use of indifference curves. His conclusion is that, even if the same amount of revenue is exacted, an individual is better off under a proportional than under a progressive income tax and still better off under a regressive one. Friedman questions the validity of Boulding's result because he thinks Boulding is one of those who base their arguments on a fallacious proof, although Friedman does not set out his criticism in detail. Since Boulding's results, if valid, are of great significance and since the weak point of his analysis cannot be derived directly from Friedman's contributions, it is the purpose of this paper to show the limitations of Boulding's conclusion, which, if known, would deprive it of much of its generality and usefulness.

Type
Research Article
Information
Canadian Journal of Economics and Political Science/Revue canadienne de economiques et science politique , Volume 21 , Issue 1 , February 1955 , pp. 43 - 51
Copyright
Copyright © Canadian Political Science Association 1955

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Footnotes

*

I am indebted to K. E. Boulding, D. A. Moore, L. S. Ritter, and E. Schwartz for comments on an earlier draft of this paper.

References

1 Little, I. M. D., “Direct versus Indirect Taxes,” Economic Journal, LXI, 09, 1951, 577–84CrossRefGoogle Scholar; Friedman, Milton, “The ‘Welfare’ Effects of an Income Tax and an Excise Tax,” Journal of Political Economy, LX, 02, 1952, 25–33.Google Scholar For a list of the contributors to the subject, see Friedman's article, 25–6, n. 3.

2 Little, , “Direct versus Indirect Taxes,” 578.Google Scholar Writers who accept the alleged proof seem to have shared Frisch's failure to see the force of Hotelling's emphasis on the essential point of difference between Frisch and Hotelling, namely, that Hotelling takes account of conditions of cost of production; Econometrica, VII, 04, 1939, 145–60.Google Scholar See in particular, Hotelling's final note, 158–60. Both Little and Friedman referred to the original Frisch-Hotelling controversy in their respective articles as the background of their analyses.

3 Boulding, Kenneth E., Economic Analysis (rev. ed., New York, 1948), 773–5.Google Scholar

4 Friedman, , “‘Welfare’ Effects of Income Tax,” 25–6, n. 3.Google Scholar See also Phipps, C. G., “Friedman's ‘Welfare’ Effects,” Journal of Political Economy, LX, 08, 1952, 332–4CrossRefGoogle Scholar; Friedman, Milton, “A Reply,” Journal of Political Economy, LX, 08, 1952, 334–6.CrossRefGoogle Scholar

5 This and the following section are largely based on that part of Friedman's contribution which is not affected by the points raised in Phipps's article.

6 If the initial position is not one of competitive equihbrium, no generalization can be made on the welfare effects of such a change. See Rolph, Earl R. and Break, George F., “The Welfare Aspects of Excise Taxes,” Journal of Political Economy, LVII, 02, 1949, 45–54.Google Scholar

7 “Welfare Aspects of Excise Taxes,” Journal of Political Economy, 45–54.

8 Schwartz, EIi and Moore, D. A., “The Distorting Effects of Direct Taxation: A Reevaluation,”, American Economic Review, XLI, 03, 1951, 139–48.Google Scholar

9 Ibid., 144.

10 Little, , “Direct versus Indirect Taxes,” 584.Google Scholar

11 Survey of Current Business, 01, 1950, 17–20.Google Scholar

12 See my “Income Elasticity of Demand for Imports and Terms of Trade,” American Economic Review, XXXIX, 09, 1949, 966–70.Google Scholar

13 Little, , “Direct versus Indirect Taxes,” 582.Google Scholar

14 The family unit has been used by the Census Bureau. The Federal Reserve Board adopts the spending unit as the basic unit for the consumer financial surveys. A spending unit “may consist of a financially independent single individual, or of several related persons who live in the same household and who pool their major items of income and expense.” Young, Ralph A. and Holthausen, Duncan McC., “Values and Limitations of Consumer Financial Surveys for Economic Research,” reprint from the Federal Reserve Bulletin, 03, 1947, 8.Google Scholar