TAX INCIDENCE IN A TWO-SECTOR GENERAL EQUILIBRIUM MODEL

This study investigates the structure of tax incidence in a two-sector general equilibrium model, carried out both in the static and dynamic settings. In the static setting, a labor supply function is derived explicitly from utility maximization to bring out clearly the impact of taxation on work-leisure choice. An important theorem which provides a sufficient condition for the famous Harberger result to remain valid under variable labor supply in derived and explained. Other issues analysed include the direct-burden and the excess-burden of taxation, their relationship to zero vs. non-zero existing taxes, and the structural relationship among various tax schemes. A simulation is undertaken to examine the sensitivity of tax incidence results to various important parameters.; The static framework is extended to a two-period dynamic context in which the emphasis of the analysis is on the impact of taxation on capital accumulation under both the settings with and without bequests in the system. A related issue is the intertemporal shifting of tax incidence through tax-induced adjustments in savings. The novelty of the model is in the full endogenization of saving decisions through intertemporal utility maximization. An extensive simulation study tests how the incentive to save and invest is influenced by various tax schemes, among them the income and expenditure taxes.