Conclusion:

An analysis of optimal taxation has bridged the gap between welfare economics and realities of public policy to a large extent. The optimal tax theory addresses specific questions like, should additional revenue be mobilized by introducing a value added tax or by raising tax rate on income or even by strengthening tax administration.

Since the optimising taxpayers have incentives to exploit private information, which may not be available with the government,  how to deal with dishonest taxpayers remain an important challenge for the government. The questions optimal tax theory seeks to answer are essentially normative but policy prescriptions in public economics are in the realm of positive analysis. The  normative approach provides a framework for examining the policy questions and it can essentially be a guide for policy issues.

However, what the government can do depends on information availability with the government in setting up a tax system. Ramsey rule was found to be inequitious. It is not surprising as the focus is mainly on minimisation of inefficiency or excess  burden. In practice one has to assign different weights in the social welfare function to resolve this crucial trade-off between efficiency and equity objectives. Based on empirical measures of elasticities, the government can find out tax rates to be applied, which is right for the economy, given the objective. Take for example the case of the salaried individuals. Given their nature of  work, higher tax rates would cause very little distortion unless they decide to quit the job market and do something else as the possibility of substitution is very limited. One has to therefore examine the reality against the backdrop of the underlying  assumptions of the model. Given the complexities involved, actual determination of the tax schedule often boils down to a political decision. Under different valuation of the objectives, the government would come up with different tax schedule. The optimal tax theory provides reliable intuition with well-founded arguments, which are important for policy decisions in taxation. The theory is yet to come to terms with the very fact that imposition of taxes entails resource costs incurred by the taxpayers and other  supportive institutions like banks, courts, police and most importantly tax administration. The resource cost varies with the tax instruments, rate structure, tax administration and extent of tax evasion.

It is suggested that there is a need for an optimal tax system, an alternative to the conventional optimal taxation, which would minimise resource cost (Slemrod 1990). Tax compliance cost, the third of Okun's leaky bucket is an important cost item of the total resource cost incurred by the society. Optimal tax theory emphasises mainly upon labour and capital market imperfections. In tax policy matters, the government therefore is assigned with a very challenging task. New insights have been gained into the mode  of balancing various conflicting objectives of the economy, such as efficiency and equity. The optimal tax theory makes an  important contribution to the decision making process in identifying issues, the dilemma, the hard choices the government has to confront with and their implications on the economy in a theoretical framework. Whether optimum tax formula can be taken  seriously in designing a tax system remains a moot question when resource costs, or, the other two sources of 'leaks' are kept out of purview.