TITLE:
A Note on Time Discretion and the Welfare Cost of Lump-Sum Taxation
AUTHORS:
Cristian F. Sepulveda
KEYWORDS:
Tax Distortions, Lump-Sum Tax, Labor Income Tax, Time Discretion
JOURNAL NAME:
Theoretical Economics Letters,
Vol.8 No.2,
February
8,
2018
ABSTRACT: The lump-sum tax is broadly regarded by standard
optimal tax theory as the only non-distortionary tax instrument; any other tax
instrument distorts relative prices and thus creates a deadweight loss. This
paper discusses an unintended effect of lump-sum taxation that can be considered
a distortion of the time endowment. Whenever this tax exceeds the amount of
non-labor income, it reduces the taxpayer’s ability to freely allocate her time
endowment. As long as the taxpayer assigns a positive value to time discretion,
the lump-sum tax creates a welfare cost that has not been identified in the
relevant literature. The welfare cost of the lump-sum tax could plausibly be
greater than the traditional measure of deadweight loss of an equal yield labor
income tax, which does not affect time discretion. Since the lump-sum tax does
not unambiguously lead to a greater welfare level, we can conclude that it is
not a proper efficiency standard at low levels of non-labor income. The same
argument can be used to call for caution in the use of taxes based on the value
of assets that are not the source of income flows, like owner-occupied property
taxes and some types of wealth taxes. At low levels of non-labor income, these
tax instruments will also have a negative effect on time discretion.