Linear Commodity Tax Reform and the Limits of Partial Uniformity

This paper studies the desirability of tax reform toward uniform taxes on a subset of commodities under nonlinear income taxation, when commodity taxes are restricted to be linear. Suppose that preferences are partially separable between a subset of goods and labor supply. We first show that, in the presence of linear taxation on all goods, a Pareto-improving tax reform toward partially uniform commodity taxation fails to satisfy incentive compatibility. Furthermore, distortions in production that alter relative wages can improve welfare by relaxing incentive-compatibility constraints. We then show that there is no local Pareto-improving direction from uniform taxation within a separable group of goods if and only if the demand functions for these goods exhibit parallel income effects across income classes. This result highlights that, under the restricted policy instruments, constraints on commodity demands remain essential even under nonlinear income taxation.