How should commodities be taxed?
A counter-argument to the recommendation in the Mirrlees Review
The Mirrlees Review recommends that commodity taxation should in general be uniform, but with some goods consumed in conjunction with labour supply (such as child care) left untaxed. This article examines the validity of this claim in an optimal income tax framework. Contrary to the recommendation of the review, our theoretical results imply that even if all goods other than the good needed for working are separable from leisure, the optimal tax on these goods should not be uniform. Instead, commodity taxes should discourage consumption of goods with large expenditure elasticities. Our results imply that the optimal commodity tax system is dependent on the expenditure side of the government. For instance, if the government fully subsidizes the cost of the good needed for working, then commodity taxation is uniform under the standard separability assumption. Calibration exercises suggest that these results can be quantitatively important.