Question

4. You have been asked to write a policy brief to the Minister of Finance outlining some implications of salience for tax policy. The Minister is busy and can only read one page policy memos. Also, while the Minister is clever and understands economic concepts on a general intuitive level, she does not have an economics degree. For example, she understands the notion of elasticity. Thus, you can be “quasi-technical” but not “overly technical” in your use of jargon. Write this policy memo. Here are your guidelines:

Answer 1

The taxation is the main source of income for the government. The government earns major part of the revenue from taxation and then spend it on various development and social programs. The tax policy is very important for an economy in the sense that it has many implications. A wrong tax policy can shut down the entire economy as it affects the consumption patterns of consumers and creates dead-weight loss in the society.

The taxes are of two types, one is direct tax like income tax, wealth tax and second is indirect tax like tax imposed on goods and services, etc. Let's talk about the direct tax like income tax. The government should use progressive taxation system in which it imposes high tax on wealthy and rich people and low or no taxation to middle class and poor families. It is right to impose higher tax on rich and wealthy people so that a part of their income goes to government and it can be used in various government sponsored programs. The economically backward groups can enjoy no income tax as their incomes are already very low and generally used for the consumption of daily living needs. The progressive taxation system helps an economy to reduce the income inequality in the economy. Generally, the larger portion of the wealth are controlled by small number of people in the economy. The progressive taxation takes the excess amount from wealthy people and distribute them among economically backward groups in the form of various social schemes and promotes income equality.

Another type is indirect taxes which are placed on goods and services. The indirect taxes distorts the consumption patterns of the consumers in the market which negatively affect the aggregate demand. A higher indirect tax can lead to a very low demand for that particular good or a service.In case of indirect taxes, the government should impose indirect taxes on those goods which have inelastic demand, it means there will be a no change in demand if the price changes. By imposing taxes on inelastic goods, the government can earn the tax revenue without distorting the consumption pattern and aggregate demand.

The government should also keep in mind the Laffer curve in mind that imposing too much taxation on the goods and services would lead to fall in the government tax revenue.