In: Economics
This week we are studyiing about Principles of Microeconomics, Ch. 12: The Design of the Tax System. I need assistance with the below questions.
Consider the following:
Consider what is meant by the efficiency of a tax system?
What can make a tax system inefficient?
Explain the benefits principle and the ability-to-pay principle.
What are vertical equity and horizontal equity?
Why is studying tax incidence important for determining the equity of a tax system
1) Consider what is meant by the efficiency of a tax system?
Answer : The efficiency of a tax system deals with the relative costs it imposes on taxpayers due to functioning of the system . There are two costs of taxes other than the monetary payments made by taxpayers to the government . Firstly , cost arises as taxes alter incentives and behavior . Suppose if marginal income tax is very high then it reduces incentive to work harder for more income .
The second cost is the administrative burden of acting in accordance with the tax laws . Implementation of tax laws is a kind of cost . If these two costs are relatively low , then the tax system is efficient . If these two costs are relatively high, then the tax system is inefficient . Inefficient taxes cause an inefficient allocation or wastage of economic resources and thus are generally considered to be less desirable than efficient taxes .
2) What can make a tax system inefficient?
Answer : A tax system can be made inefficient due to the following reasons : dead weight loss arising from market distortion after taxation , very high taxes can lead to evasion and thus requires extra administrative costs for enforcement , tax laws create uncertainty , corruption etc .
3) Explain the benefits principle and the ability-to-pay principle.
Answer : The benefit principle means that people should pay taxes based on the benefits they receive from government services . As for example , those who benefit from a river cleaning programme pay the costs of the programme . So a public good gets the features of a private good because only those who benefit from them pay for them .
The ability-to-pay principle is the idea that taxes should be levied on a person according to how well that person can carry the burden . It tries to equalize the sacrifice each person makes toward paying taxes by imposing the tax burden directly to one's income and wealth .
4) What are vertical equity and horizontal equity?
Answer : Both the concepts are like the two sides of a coin . Vertical equity is the idea that taxpayers with greater ability to pay taxes ( more income ) should pay larger amounts of taxes . It is the idea that people who have the ability to pay more should do than people who do not have the ability . Horizontal equity is the idea that individuals with similar abilities to pay taxes ( similar income and assets ) should pay the same amount of taxes .
5) Why is studying tax incidence important for determining the equity of a tax system
Answer : It is important for determining the equity of a tax system because realising how equitable the tax system is understanding the indirect effects of taxes . In many cases, the burden of the tax is borne by individuals other than those who actually pay the tax . Such as producers shifting the whole tax to consumers buying their products . Let us consider the example of medicines which is highly inelastic good . Since medicines is a necessity , taxes are shifted to consumers . Producers profit huge amounts by selling medicines at higher price and the people who buy medicines are not all well off , so they suffer from high tax burden .