Question

Suppose the government needs to raise funds for its expenditures by a proportional income tax.
Explain in words why there could be two tax rates (i.e. two equilibria) that could raise the required funds for the government.

Answer 1

Yes, Government should raise funds for its expenditures by a proportional income tax because a proportional tax is a tax that levies same percentage tax to every earner. The proportional tax is same for low, middle and high income group.

There could be two taxes to raise required funds for the government because adding a higher amount in one tax system may be a burden for all income groups, they may feel discouraged to earn. So to raise funds for government expenditure, it should impose another tax system on those goods which are not necessary for the consumers but they consume due to their habits or to maintain a luxurious lifestyle. These goods include, tobacco, alcohol, petrol and diesel.

Government can levy a high tax on cigarettes and other tobacco products to discourage its consumption and symultaneously can raise the required funds for its expenditure. Similarly, alcohol is not good for health, people know it well but still they consume it as it is their regular habit or some people take it as their status symbol, in that case, government can take advantage of this situation and raise the tax amount to gather funds for its expenditure. Similarly, petrol and diesel pollutes our environment, to attract more people towards the use of public transport, government can raise tax amount on petrol and diesel, so that there could be less number of vehicles on road.

In this way, government can impose another tax rate on the non-essential goods to raise funds for its expenditure without putting financial pressure on any income group.