Household Production and the Design of the Tax Structure

This paper amalgamates two topical issues in the economics of commodity taxation: the general case for non-uniformity, and the tax treatment of commodities that are either inputs to household production or close substitutes for household produced goods. Assuming a redistributive objective and that the government can implement a non-linear income tax system and linear commodity taxes we investigate if the existence of household production generates a natural case for non-uniform commodity taxation. Four main results are reported. First, when the set of commodities is partitioned into consumption goods and input goods, and commodity taxes are restricted to being within-group uniform, the composite commodity theorem can be used to characterize the optimal commodity taxes. Secondly, sufficient conditions for within-group uniform commodity taxes to be fully optimal are derived. Thirdly, we argue that an input good should be taxed at a higher rate than general consumption if and only if the degree of complementarity in household production (between the input good and a time-input) is larger than the degree of complementarity in consumption (between general consumption and the household produced good). Finally, we show that under simple normality, a market substitute for the household-produced good should be taxed at a lower rate than general consumption. The intuition for the last two results is that the suggested pattern of taxation discourages "do-it-yourself" behaviour, which relaxes the self-selection problem.