Question

The two most important state taxes are income and general sales taxes, although states also make substantial use of excise taxes, direct business taxes (usually a corporate income tax), and others. List and discuss briefly four factors that might influence a state in choosing between an income and general sales tax. What is the relative reliance in NY state on these two taxes? If the relative reliance in NY state is different than average, speculate about why that might be so.

Answer 1

From the economic point of view, it is generally preferable to charge a direct tax as compared to the indirect tax in the form of sales tax, excise duty etc. This is because when the government collects more revenue using direct taxes as compared to indirect taxes the, the consumer will move on a higher indifference curve and will have greater satisfaction as compared to indirect tax case. Also. direct taxes are more progressive as compared to indirect taxes which are regressive and are computed at same rate for all irrespective of income.

However, in choosing the relative reliance between direct and indirect taxes it is seen that governments generally prefer indirect taxes as they are easy to monitor as compared to direct taxes where due to existence of black economy, tax evasion is high. indirect taxes will fetch more net revenue to the government as the cost of collection is low and collection is convenient. Also, tax evasion is difficult in case of indirect taxes. In New York also, the tax system is regressive with most of the revenue coming from Sales and Excise taxes though it is lower than the national average but relative reliance is more as compared to direct taxes. This is because of variety of exemptions for goods and services that are a part of sales tax revenue. NY also allows local government to levy additional sales tax. So, sales tax base should be increased.