Question

In: Economics

Two consumers A and B have incomes of $30,000 and $100,000, respectively. A and B consume...

Two consumers A and B have incomes of $30,000 and $100,000, respectively. A and B consume the same bundle of goods with a cost (including tax) of $24,000. The only tax in the economy is a commodity tax levied uniformly on all gods at a rate of 20 percent.

What proportion of income is paid in tax by A and B?  

What implications does such a tax have in terms of equity?  

Is there any way the commodity tax can be restructured to improve its equity properties?  

Expert Solution

1.

Let, price of the commodity = X

Then

(X+20*X) = 24000

X = 24000/1.2 = $20000

Tax paid = 24000-20000 = $4000

So,

Proportion of income spent in tax by consumer A = 4000/30000 = 13.33%

Proportion of income spent in tax by consumer B = 4000/100000 = 4%

2.

It implies that as the income increases, there is decrease in the proportion of the income being spent upon taxes. So, it encourages inequality and disparity among the different classes of people. It is an example of regressive taxation system.

3.

Yes, commodities can be classified into the different categories and accordingly the tax should be applied. For example, the commodities as necessity goods should be tax free and luxury goods should have a higher amount of tax. Further, the goods causing negative externality such as tobacco products should have higher taxes, but medicines should have lower taxes. It will help the poor and government will also earn revenue.

Rahul Sunny answered 2 years ago

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