Question

(a) Briefly explain what a regressive tax is and give an example of such a tax.

(b) Explain the concepts of horizontal and vertical equity as applied to tax systems.

Answer 1

a) A tax is imposed on income or consumption of goods or services which is the source of government revenue. The tax incidence should be structured in a way that it should be paid more by those who earns higher income and the low income people should have a lesser burden of it.
If the tax burden increases with level of income or with the level of consumption of any good or service then it is called as progressive tax such as income tax.
However, if the tax burden is higher on the lower income or lower consumption category then it is a regressive tax.
There is no regressive tax but flat tax in reality acts as a regressive tax because its burden is more on low income category. The sales tax is a flat tax on each product and it is an example of regressive tax.

b) The structuring of the tax is difficult because it is the revenue of the government and it should be maximum but the higher tax burden decreases the disposable income of the people and so consumption takes a hit.
There could be ambiguity about the tax rate but there is a quite consensus about taxing principle.
The people with equal income should actually pay an equal tax and this known as horizontal equity.
On the other hand, people with higher income should pay a higher tax because they are earning more and should share a higher burden. This is known as vertical equity.