Theory and Policy: A Commenton Dixit andon Current Tax Theory

IMF Working Papers, February 1, 1992

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In a recent paper Professor Dixit criticized the argument that when collection lags characterize tax systems, recourse to inflationary finance should be minimized.
Dixit argued that, in such case, rather than minimizing recourse to inflationary finance, the rates of the commodity taxes should be adjusted to maintain them at an optimal level and, thus, to minimize welfare costs.
This paper shows that the requirements for following Dixit’s policy prescription are almost impossible to meet.
The paper argues that more attention should be paid by tax theorists to the constraints under which tax reforms are made.

Collection lags in tax systems prompt debate over whether to minimize recourse to inflationary finance or to adjust commodity tax rates.
The author assesses Dixit’s prescription and finds the practical requirements for implementing that prescription to be nearly unattainable.
Emphasis is placed on the real-world constraints that limit the feasibility of theoretically optimal tax-rate adjustments in response to inflation and collection delays.

Policy prescription by Dixit—to adjust commodity tax rates to an optimal level instead of minimizing inflationary finance—faces implementation obstacles that make it impractical in most settings.
Tax theorists should pay more attention to the constraints under which tax reforms are made when deriving policy recommendations.
Implicit recommendation for policymakers: consider feasibility and institutional constraints alongside theoretical welfare-minimizing solutions when designing tax responses to inflation and collection lags.

Subject: Consumption taxes, Inflation, Prices, Taxes
Keywords: collection cost, Consumption taxes, cost, Dixit, Global, implicit recommendation, Inflation, inflation rate, inflation tax, policy option, rate of inflation, tax practitioner, tax rate, theoretical analysis, WP