June 2014 will be the fortieth anniversary of my first publication with Tom Asimakopulos who was my principal PhD supervisor at McGill. You can all read and my CV is public information. Inspection of it reveals that I have written on too wide a variety of topics with many co-authors over the past four decades. Economics teaches us about the advantages of monopoly power and researchers who focus on a particular area of economics and make themselves one of the world’s experts in that area do much better than those, like me, who work on whatever happens to interest them year by year. You have given an old man an opportunity to talk and old men tell stories. Here is the story of a paper that will be published by the Canadian Journal of Economics (CJE) later this year.
As an application of income and substitution effects second-year micro instructors will often use a two-period consumption diagram to show that an interest tax is inefficient relative to either a proportional earnings tax or a proportional consumption tax; for the same tax revenue raised it leads to lower utility. I have used numerical simulations to teach my courses for about thirty years. In a graduate class at McMaster in the late 1980s I used a numerical simulation of a two-period model to show the students something everyone knew — an interest tax is inefficient relative to earnings or consumption taxes. With a leisure, as well as a consumption, choice in the model we discovered examples where an interest tax improves the efficiency of a wage tax or consumption tax.
Trying to understand the role of interest taxation in life-cycle models led eventually to an article on distance functions by Angus Deaton in the 1979 Review of Economic Studies. Using Deaton’s framework, the students and I published an article on optimal taxation in a life-cycle model in the 1992 CJE. Subsequently Besley and Jewitt (Journal of Public Economics 1995) showed that Deaton did not get the necessary and sufficient conditions for the efficiency of uniform commodity taxation quite right and I realized that there were mistakes in our 1992 article on taxation in a life-cycle model in the CJE. After 1995, new articles on interest taxation appeared in the Journal of Economic Theory and the American Economic Review but these papers also didn’t quite capture the way interest taxation actually works. It is my hope that the paper coming out in the CJE later this year sets the record straight.
A pdf of “Using distance functions to understand interest taxation” is on my web site. Section 2 of this paper is currently being used to torture Winter 2014 Econ 401 students with distance functions. The lead footnote thanks Simon Chen, a student in the Winter 2013 Econ 401 class, and now a graduate student at MIT. Simon found an error in the paper which has been corrected – thank you Simon!
written by Prof. John Burbidge for the Economics Society