Labor incomeis paid for the
work effort that
a person puts
income is paid to people for the resourcesthey provide sothat companiescan purchasebuildings and machines used to produce goodsand services.
orward. In their amous 1971 paper,the principle o elasticity was developed.Diamond and Mirrlees demonstratedthat the taxes that did the least harm wereones that were applied to the least elasticitems. Here, the term elasticity reers tothe percentage change in the quantity o the good or service or a given percentagechange in the tax rate.
Chamley and Judd showed that capital is extremely elastic because it is mobile. In the long run, a higher tax rate on capital will lowerthe return and result in capital feeing to a lower tax jurisdiction.Our second illustration considersextending the principle o elasticity toits logical conclusion. Land is an itemthat is completely inelastic; you cannotremove a parcel o land rom one state toanother. Tereore, land value constitutesa tax base that is inelastic and warrantsconsideration as a taxable item that doesthe least harm to Missourians. We usethe best data available to determine thetax rate that would apply in Missouri i itsought to implement a land-value tax.Te outline o the paper is as ollows: InSection 2, we lay out the economy thatChamley and Judd studied. In doing so, we oer a more precise denition o what we mean by the phrase “least harm.” Weconduct our numerical experiment orthe Missouri economy in Section 3. Werelax the assumption that income mustbe taxed in Section 4, proposing a tax on land value as an alternative. Section 5oers a brie summary o our ndings.
2. The Model Economy
A model captures the key eatures o the actual economy. Here, three maintradeos are captured: (1) peoplemake decisions within each yearbetween working, which is costly, andconsuming, which requires, in part,the income rom working; (2) peoplemake decisions about consuming thisyear versus consuming in the uture;and (3) rms decide how intensively to use capital and labor. Clearly, this isnot an exhaustive list o decisions, butit embodies key dimensions that matteror economic well-being. In particular,item 2 is a airly straightorward way tocapture the dynamic eects associated with people’s consumption-saving decision. People look into the uture toproperly capture this tradeo. We begin by describing how thiseconomy works. For example, we need todescribe who lives in the economy, how long they live, and what kind o thingsthey want to buy and sell.How long does this economy last? Weonly need two periods in order to getthe consumption-saving decision to beoperational. In order to get a sense o the long run, however, we think o thiseconomy as lasting or a long time. Tislength o time is divided into periods. Forour purposes, each period is a year. When we get to the analysis, the nice thing isthat the decisions are easily characterizedas i it is about consumption this year andconsumption next year. So, any graph hasonly two dimensions. Who lives in the economy? Te number o people is very large so that no one personpossesses any market power. Put another way, each person takes prices as i they aregiven and cannot implement any unilateraldecision that will aect those prices. We donot need to have an exact number, because we will assume that people are identical,at least with respect to their decisionsregarding current consumption (this period)and uture consumption (next period). Inaddition, everyone lives or two periods.