Uncertainty, Optimal Taxation and the Direct Versus Indirect Tax Controversy

Abstract

This paper examines how the presence of uncertainty affects the design of tax policy when both indirect taxes and a general income tax are available to the government. There are two categories of goods: the consumption levels in one group are committed to before the resolution of uncertainty and those of the other after. The paper proves that contrary to Atkinson and Stiglitz's (1976) result, differential commodity taxation remains a useful instrument of optimal tax policy even if preferences are separable between labour and produced goods.

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