Question

1.     You are advising the government on how to pay for national defense. There are two proposals for a tax system to fund national defense. Under both proposals, the tax base is an individual’s income. Under proposal A, all citizens pay exactly the same lump - sum tax, regardless of income. Under proposal B, individuals with higher incomes pay a greater proportion of their income in taxes.

a.     Is the tax in proposal A progressive, proportional, or regressive? What about the tax in proposal B?

b.     Is the tax in proposal A based on the ability - to - pay principle or on the benefits principle? What about the tax in proposal B?

c.     In terms of efficiency, which tax is better?

Answer 1

a)The tax in proposal A is proportional .A proportional tax provides the same tax rate to all individuals regardless of income.The tax in proposal B is progressive.The progressive tax system imposes more percentage of taxes on people of higher income level based on the principle that high income levels can afford to pay more.Eg income tax.

b)The tax on proposal A is based on the benefit principle and not on the ability to pay principle.The proportional tax imposes same relative burden on all tax payers as the tax rate is fixed.The benefit principle determines the activities the government will undertake and who will pay for them.The benefit principle is used in financing roads and highways.

The tax in proposal B is based on ability to pay principle.Ability to pay is progressive taxation principle which states that taxes should be levied on individuals ability to pay and rich should paymore.

c)It is argued that flat rate is esay for tax payers to calculate.It is more efficient, more fair as everyone is taxed at the same rate. Same relative burden is imposed on all tax payers . Advocates of proportional tax rate suggest that in progressive tax creation of wealth gets discouraged because higher levels of income have to pay higher tax rate.Advocates of the progressive system claim that it reduces the burden of the poor.So both tax system has advantages and disadvantages.These advantages and disadvantages do not allow one system to be more efficient than the other.