**1. Introduction**

Tax is the main source of income, which is collected based on the sovereign authority of the government. In this context, taxation is one of the primary political tools that states use in order to obtain economic, social, and political goals. Taxation as a fiscal policy tool allows states to make effective practices in achieving their goals in macroeconomic terms. The role of tax policies in

© 2016 The Author(s). Licensee InTech. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. © 2018 The Author(s). Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

the matter of obtaining the aforementioned macroeconomic goals reveals that taxation is one of the effective economy policy tools in the hands of the state. In accordance with the social state approach, taxation emerges as a transfer mechanism. Enabling equality/justice for each individual is accepted to be at the helm of the duties of states toward their citizens.

The most important criticism toward this rule originates from the fact that necessity goods devoted to meet basic needs have low price elasticity of demand, and luxury goods on the other hand have high price elasticity. Taxing luxury goods at a lower rate compared to necessity goods under the assumption that consumers resemble each other is claimed to influence

Optimal Taxation of Consumption in the Scope of Changing Elasticities of Demand...

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The assumption that luxury goods have high demand elasticity and necessity goods have low demand elasticity may change when short and long periods are in question and within the context of competition, which is the main incentives of market economy. In assuring the profit maximization, which is the main goal of firms competing in the market economy, their total revenues and demand elasticity for their products are important variables. Firms can increase their total revenues by decreasing the demand elasticity for their products. In this context, firms aim to reduce the vulnerability of the product they produce against price changes.

As markets open to foreign countries, together with the liberalization in trade, magnitude of the market and innovation increases, and this may increase price elasticity of demand by increasing substitution possibility of especially necessity goods [5–7]. On the other hand against this risk, firms try to lower the demand elasticity of their products within the context of the brands they create and by increasing loyalty to these brands [8]. Especially, in product groups including luxury goods such as technological products and automobiles, brand loy-

Within this framework, changing market conditions changes demand elasticity of luxury and necessity goods, and this change on the other hand necessitates reassessing basic assumptions

The most fundamental goal of economic and fiscal policies is to maximize wealth. This goal includes quite large sub-goals, such as providing stability, growth, efficient allocation of resources, and fair income distribution. Tax is the primary fiscal tool to be used in reaching the goals in question. Among the tax applications that are under the changing and developing state understanding, what type of taxation is the taxation that serves the goal of wealth maximization is considered in the literature especially in the framework of "Optimal Taxation" theory. While within classical welfare economics understanding, optimal taxation theory considers taxes as effective tools in assuring resource allocation; new welfare economics' view of utility measurement and impossibility of inter-personal comparisons caused economic area of interest to rotate to Pareto efficiency. This situation focused on substitution effect of taxes, creating efficiency loss and lasted until the study of Mirrlees [2], which targets resolution of equality

In this context, optimal taxation is the taxation that reflects the preferences of the society between equality and efficiency with rivaling goals, and that has social wealth maximization

alty reduces the sensitivity of consumers to the product's price.

of optimal taxation and criticisms against optimal taxation.

**2. Optimal taxation**

and efficiency conflict.

justice of taxation in a negative way.

Citizens belonging to all income groups in a country to be able to benefit from public services within the context of equality and justice principle on the other hand can only be possible by the state to transfer the resource, which is collected from the higher income group via taxation to lower income groups as public services. Within this framework, taxation is the most important element of the transfer mechanism between income groups.

How to design taxes, which are the most important policy tools of the state in reaching the goal of effectiveness and equality, has been comprehensively discussed in the optimal taxation literature. Optimal taxation is a taxation, which reflects the preferences between the society's rivaling aims of equality and economic efficiency and which has maximizing social wealth as the starting point.

In today's conditions, in which the state has asymmetrical information about the individual's social and economic characteristics, the goal of income redistribution can be possible through the use of distortionary taxes. The state can assure income justice by using distortionary taxes only by conceding economic efficiency. Because of this reason, optimal taxation lays emphasis on tax subject, tax rate, and tax base, which will minimize thrashing in securing a certain amount of tax revenue.

In this context, two main studies exist in the optimal taxation literature with regard to tax subject. In his study, Ramsey [1] approached optimal tax subject on the basis of consumption, and in the second fundamental study, Mirless [2] identified revenue as the tax subject. In both studies, ideal tax rates were searched within the context of the determined tax subject.

In the Ramsey approach to optimal taxation, since the needed budget revenue is possible to be obtained only by distortionary taxes under the assumption that it is not possible for governments to resort to lump sum taxes, it will bring along a wealth loss in terms of economic efficiency and will move away from the optimal solution. Within this framework, Ramsey emphasizes on the tax subject and rate that will minimize efficiency loss. In Ramsey approach, it is generally agreed that the government can impose a linear income tax besides commodity tax [3].

Optimal commodity taxation, which was proposed in 1927 by Ramsey and whose theoretical structure has developed through today's modern approaches, is based on the inverse elasticity rule, which claims goods with low demand elasticity to be taxed at a higher rate will reduce efficiency loss, and Corlett-Hauge Rule [4], which claims leisure complement goods that will change the preferences of consumers between working and leisure on behalf of working need to be taxed at a higher rate.

In the inverse elasticity rule suggested by Ramsey, all goods are aimed to be affected equally from taxes by levying taxes at a high rate from goods with low demand elasticity and at a low rate from goods with high demand elasticity.

The most important criticism toward this rule originates from the fact that necessity goods devoted to meet basic needs have low price elasticity of demand, and luxury goods on the other hand have high price elasticity. Taxing luxury goods at a lower rate compared to necessity goods under the assumption that consumers resemble each other is claimed to influence justice of taxation in a negative way.

The assumption that luxury goods have high demand elasticity and necessity goods have low demand elasticity may change when short and long periods are in question and within the context of competition, which is the main incentives of market economy. In assuring the profit maximization, which is the main goal of firms competing in the market economy, their total revenues and demand elasticity for their products are important variables. Firms can increase their total revenues by decreasing the demand elasticity for their products. In this context, firms aim to reduce the vulnerability of the product they produce against price changes.

As markets open to foreign countries, together with the liberalization in trade, magnitude of the market and innovation increases, and this may increase price elasticity of demand by increasing substitution possibility of especially necessity goods [5–7]. On the other hand against this risk, firms try to lower the demand elasticity of their products within the context of the brands they create and by increasing loyalty to these brands [8]. Especially, in product groups including luxury goods such as technological products and automobiles, brand loyalty reduces the sensitivity of consumers to the product's price.

Within this framework, changing market conditions changes demand elasticity of luxury and necessity goods, and this change on the other hand necessitates reassessing basic assumptions of optimal taxation and criticisms against optimal taxation.
