Thoughts on economics and liberty

Optimal taxation, levies, fees and charges

I started this a couple of days ago to comment on the Opportunity Card, but I will make personal notes on general principles of optimal taxation on this placeholder post.

  • Need to distinguish between taxes and levies.
  • What are the principles applicable to taxes? What principles apply to levies?
  • Why should cost recovery be limited to 100 per cent?

Wikipedia Optimal Tax

Review of State Business Taxes, 2001.

The Pros and Cons of a Consumption Tax



Moving governments towards price discriminatory taxation and fees – using an Opportunity Card

In 2009 I published two articles in Freedom First outlining a theory of public finance underpinned by a perfectly price discriminating model.

These articles are available here: first, second.

The real issue with price discrimination remains the cost of assessing the individual willingness to pay and hence the potential consumer surplus (or loss – if price of a government service is greater than its value to an individual).

I found a useful video on price discrimination by Tyler Cowen. Please review it here. Very worthwhile. It shows that if a monopolist does get access to consumer data, price discrimination becomes more feasible. This is used to help children of poor parents by universities in the USA. It also illustrates the extreme usefulness of this idea, which has been under-used in public policy circles.

However, I now understand that “While (third ­degree) price discrimination has until recently been considered a passè topic, several papers have recently appeared in top journals.” [Source]

I chanced upon this article: The Government May Want to Encourage Price-Discrimination by Income – by David Reinstein, which proposes what I think is an excellent idea. That the government issue an Opportunity Card which could allow businesses to price discriminate more actively.

However, there is a much bigger opportunity here – for government to use Opportunity Cards to price discriminate its services. Progressive income taxation is a reasonable approximation to price discrimination. But most other taxes and fees/charges do not use price discrimination. Although some such discounts are already built into the system (e.g. pensioner cards/ health cards), the best mechanism would be to use a general Opportunity Card.



What is a public good? Something that everyone wants but none feel competent to supply for a range of reasons.

The best way to consider the pricing of public goods is to consider what would a private sector company do if it was able to resolve the non-excludability problem?

We know in such a case it would be a profit maximising monopolist. And perfect price discrimination would allow it to deliver the socially optimum level of output and welfare.

(This explains why private railway companies, airlines and theatres had – and have – multiple “classes” of fares).

The government should put itself in the shoes of such a hypothetical monopolist and identify the pricing mechanism for its services that mimics perfect price discrimination – to the extent possible.

This means that some people will be charged well above marginal cost and others, well below. This should be the foundation of all tax theory and theory of levies, charges and fees.

In fact, this way of looking at things probably provides the most persuasive rationale for Adam Smith’s “ability to pay” principle and JS Mill’s “equal sacrifice” principle.

Cost recovery principle is fundamentally flawed, being a derivative of the labour theory of value. The government must behave like a profit maximising monopolist at all times, and prices must be linked only to ability to pay, not to average cost.

This can underpin a wide range of charges, such as time of use and congestion charges, different classes of service and price (e.g. first class, second class, etc.) for facilities provided in national parks, differential charges for national monuments such as Taj Mahal, progressive income taxes, and so on.

This will ensure that the maximum number of people get to use the public goods, but at a price that they can afford.

Sanjeev Sabhlok

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