<Tr> <Td> <Ul> <Li> </Li> <Li> </Li> <Li> </Li> </Ul> </Td> </Tr> <Ul> <Li> </Li> <Li> </Li> <Li> </Li> </Ul> <P> Optimal tax theory or the theory of optimal taxation is the study of designing and implementing a tax that reduces inefficiency and distortion in the market under given economic constraints . Generally, this criterion consists of individuals' utility and the optimization problem involves minimizing the distortions caused by taxation . A neutral tax is a theoretical tax which avoids distortion and inefficiency completely . Other things being equal, if a tax - payer must choose between two mutually exclusive economic projects (say investments) that have the same pre-tax risk and returns, the one with the lower tax or with a tax exemption would be chosen by a rational actor . Thus economists argue that taxes generally distort behavior . </P> <P> In the Wealth of Nations, Adam Smith observed that </P>

An optimal tax is one that minimizes the