Tax structure, welfare, and government spending: The adoption of a VAT and the causal effect on government size

This thesis examines the claim that a more efficient tax has a negative impact on taxpayers' welfare by causing a positive effect on government size. First, with a broader scope placed to judge the tax efficiency, the VAT, as an efficient tax, is shown to be more efficient than conventional microeconomics estimate because it also reduces considerable compliance and political costs as well as deadweight costs. When rent-seeking for income redistribution is taken into account, the introduction of an efficient tax always increases social welfare, because it diminishes existing welfare losses. Second, introducing the VAT has a limited effect on government growth due to two factors: substitution between tax bases and the fairly low price elasticity of demand for public goods. The substitution results from the rational choice of government to minimize political opposition, and the low price elasticity, in the face of increased supply-side efficiency, causes little increase in government spending. In contrast, demand shifts of public goods have a direct impact on government size. Thus, a careful analysis suggests that the causal direction is reversed and demand shifts define the tax structure. In the sense, the widespread adoption of VATs during the 20th century should be understood as a rational collective choice responding to the growing demands for public expenditure. The thesis confirms these arguments, using an empirical test on panel data of 29 OECD countries.