Question 1
The principle of second best states that
◦ if previously existing distortions exist, a distortionary tax may actually improve efficiency.
◦ the broader based the tax, the less distortionary it is.
◦ the more inelastic the demand for a product, the less distortionary a tax on the product would be.
◦ taxes should be constructed so that they are neutral.
Question 2
What circumstances favor nonneutral taxes?
◦ only the presence of externalities
◦ only the presence of other distortionary taxes
◦ both the presences of externalities and other distorting taxes
◦ both inelastic demand and the presence of externalities