Optimal Commodity Grouping in a Partial Equilibrium Framework

The literature on indirect taxation is usually concerned with the casewhere the number of possible di¤erent tax rates equals the number of commodities.The purpose of this paper is to characterize, in a partial equilibrium framework,which commodities should be taxed at the same rate whenever there is only onepossible tax rate. It is shown that if all the consumers are endowed with thesame weight by the social planner, i.e., in the representative agent con…guration,then necessities should be taxed while luxuries should be exempted from taxation.In the many-person con…guration, where di¤erent individuals have di¤erent socialweights, only one commodity should be taxed; it is the one that is mainly consumedby households with low social weights.