Estimation of Optimal Rates of Consumption Tax and Inflation in Iran: Application of Genetic Algorithm

Social welfare is one of the policymakers’ main challenges in different societies, and as financing government expenditures is closely related to social welfare, this issue can be very important. Considering welfare cost of consumption and inflation taxation, the government must implicit tax rates on consumption and inflation to finance budget deficit that may minimize the marginal cost of social welfare. This study calculates optimal tax rates on consumption and inflation using the optimal financing model Mankiw. At first, the research calculates price and income elasticity of eight groups of commodities based on the linear expenditure system (LES) and seemingly unrelated regression (SUR) from 1996 to 2016 to calculate the social welfare cost of consumption tax. And then a calibration method calculates the optimal consumption tax rates model on the commodity groups and the optimal inflation rates using the genetic algorithm method. The research shows that the optimal tax rate is lower on commodity groups at a lower price and income elasticity. The optimal tax rate on the essential and normal goods groups is reduced by increasing loss distribution approach, and that is increased on the luxury goods groups and there is also an increase in the scatter of the optimal tax rates. However, multi-rate tax system is approved at all levels of escape rates for parameters. The optimal tax rate is also close to -0/1 which supports Friedman’s optimal rule.