01 May 2014Working Paper Summaries

Revisiting the Classical View of Benefit-Based Taxation

by Matthew Weinzierl

President Barack Obama explains his support for progressive taxes as based on the belief that "those who've benefited most from our way of life can afford to give back a little bit more." Called the classical version of benefit-based taxation, this reasoning has been used by policymakers and scholars for centuries, but it has been assigned at best a subsidiary role in modern research on optimal tax policy. In this paper, the author revisits that view and shows how it might be incorporated into modern theory. It turns out that this classical version of benefit-based taxation fits seamlessly into the modern (Mirrleesian) approach, with results for optimal policy that depend on potentially estimable statistics. Optimal policy according to this view can take a wide variety of forms, including those that match existing policy well. More generally, to the extent that a mixture of this classical benefit-based reasoning and the more conventional welfarist (e.g., utilitarian) reasoning is a good approximation of prevailing objectives for tax policy, the model may offer a useful approach to positive optimal tax theory. Key concepts include:

The long-standing role for classical benefit-based logic in public reasoning over taxes stands in stark contrast to the momentum away from it in modern theory.
This paper explores whether we might reconcile this disconnect by incorporating the classical view of benefit-based taxation into the modern framework of optimal tax theory, thereby resuscitating it as part of how we understand policy design.

Author Abstract

This paper explores how the persistently popular "classical" logic of benefit-based taxation, in which an individual's benefit from public goods is tied to his or her income-earning ability, can be incorporated into modern optimal tax theory. If Lindahl's methods are applied to that view of benefits, first-best optimal policy can be characterized analytically as depending on a few potentially estimable statistics, in particular the coefficient of complementarity between public goods and innate talent. Constrained optimal policy with a Pareto-efficient objective that strikes a balance-controlled by a single parameter-between this principle and the familiar utilitarian criterion can be simulated using conventional constraints and methods. A wide range of optimal policy outcomes can result, including those consistent with existing policies. To the extent that such an objective reflects the mixed normative reasoning behind prevailing policies, this model may offer a useful approach to a positive optimal tax theory.