The Welfare Loss of a Sales Tax in Jordan

Amir Bakir

Abstract


This paper shows how to measure the welfare loss of a 20% sales tax in Jordan for the year 2004. It tries to fill the gap between microeconomic theory and applied research in the area of welfare economics. Applied research in this area in Jordan seems to be lacking. Initially, this paper retrieves the analysis by Hausman (1981) where he derives the expenditure function from the ordinary demand function and uses it to measure the consumer surplus. This paper clarifies some ambiguity in that paper and corrects it utilizing the Stone-Geary utility function (usually referred to as the Linear Expenditure System (LES), (u = (x1+a)(x2+b))) and its corresponding demand functions to find a differential equation whose solution yields the substitution function  which is used to measure the welfare loss of a 20% sales tax using 2004 data in Jordan.

The paper summarizes the theoretical issues involved, provides illustrations using the well known utility specifications (Stone-Geary and Cobb-Douglass), generalizes the analysis and applies it to Jordan using 2004 data.

The paper concludes that using ordinary demand functions the welfare loss of imposing a 20% sales tax in Jordan for the year 2004 amounted to JD 936 Million. The paper recommends that further investigation can be undertaken in this area by exploring the use of different demand specifications, differential taxes, price and income elasticities and different population groups.


Keywords


Measurement of Welfare Loss, Sales Tax, Expenditure Function, Substitution Function, Consumer Surplus.

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