Taxation
1.What constitutes a good tax system?
A good tax system should meet five basic conditions: fairness, adequacy, simplicity, transparency, and administrative ease. Requirements of a good tax system:
- The distribution of the tax burden should be equitable or fair. This means a person has to pay tax based on his ability to pay.
- Taxes should not ruin an efficient market system. Taxes increase the cost of production, and this means higher prices. Such situation discourages both buyers and sellers or producers. At a higher price, there is a decline in quantity demanded. In the case of producers, a higher cost of production is a disincentive.
- Taxes should serve as tools in facilitating economic stability and economic growth. Taxes can greatly help solve or minimize the economic problems of inflation and unemployment
- Tax administration should be efficient. This refers to the productivity of tax collection. In less developed countries tax collection is not efficient. There are many incomes and wealth that are not reported..
- The cost of tax administration and its compliance should be economical. The basic objective of taxation is to raise funds for government programs. But if the manner of raising such money is expensive in proportion to the taxes to be collected, then it is not a good tax system
- Taxes on commodities?
By taxes on commodities are commonly meant, those which are levied either on the producers, carriers or dealers who intervene between them and the final purchasers for consumption. Taxes imposed directly on the consumers of particular commodities, such as a house-tax. Taxes oncommodities are either on production within the country, or onimportation into it, or on conveyance or sale within it; and are classedrespectively as excise, customs, or tolls and transit duties. To whichever class they belong, and at whatever stage in the progress of the community they may be imposed, they are equivalent to an increase of the cost of production; using that term in its most enlarged sense, which includes the cost of transport and distribution, or, in common phrase, of bringing the commodity to market.
- tax burden based on consumer for a good
An important distinction: Formal Incidence: Who is legally obliged to pay the tax. Effective Incidence: Who actually bears the burden of the tax? These differ because prices can change as a result of a tax.
4.what is the deadweight loss for who else buries the burden and why?
Deadweight loss arises in other situations, such as when there are quantity or price restrictions. It also arises when taxes or subsidies are imposed in a market. Tax incidence is the way in which the burden of a tax falls on buyers and sellers—that is, who suffers most of the deadweight loss. In general, the incidence of a tax depends on the elasticities of supply and demand.
A tax creates a difference between the price paid by the buyer and the price received by the seller The burden of the tax and the deadweight loss are defined relative to the tax-free competitive equilibrium. The tax burden borne by the buyer is the difference between the price paid under the tax and the price paid in the competitive equilibrium. Similarly, the burden of the seller is the difference between the price in the competitive equilibrium and the price received under the equilibrium with taxes. The burden borne by the buyer is higher—all else being the same—if demand is less elastic. The burden borne by the seller is higher—all else being the same—if supply is less elastic.
The deadweight loss from the tax measures the sum of the buyer’s lost surplus and the seller’s lost surplus in the equilibrium with the tax. The total amount of the deadweight loss therefore also depends on the elasticities of demand and supply. The smaller these elasticities, the closer the equilibrium quantity traded with a tax will be to the equilibrium quantity traded without a tax, and the smaller is the deadweight loss.
6.Why is lump sum tax not used even though its efficient? Show their is no excess burden with lump sum tax. Use diagram.
If lump-sum taxation were available, taxes could be raised without any excess burden at all. Optimal taxation would need to focus only on distributional issues. If lump-sum taxes are not available, so the problem becomes how to collect a given amount of tax revenue with as small an excess burden as possible. In general, minimizing excess burden requires that taxes be set, so that the demands for all goods are reduced in the same proportion. For unrelated goods, this implies that tax rate should be set in inverse proportion of demand elasticities.
7.Excess burden taxes efficiency.
Marginal Excess Burden := The excess burden of an extra £ raised in taxes.
(This is generally higher than the average burden, as should tax least distorting commodities first.)
- A good tax system should impose taxes with least excess burden first.
- Then move on to those taxes with higher excess burden.
- Optimally, the marginal excess burden of each tax instrument should be the same.
What is tax incidence with elasticity?
Tax incidence or tax burden does not depend on where the revenue is collected, but on the price elasticity of demand and price elasticity of supply.
When demand is more elasticity than supply, producer pay higher tax than supply is more elasticity than demand. Consumer pay higher tax too.
- Show taxes are more effective on inelastic goods.
In the case of goods with inelastic demand, because consumers are much less sensitive to price changes of these goods, the bulk of the tax can be passed on by the firm, as the diagram below shows:
Here the quantity has only fallen very slightly and the price has risen almost by the full amount of the tax. In fact, if the demand for the good had been perfectly inelastic, then all the tax could have been passed on as a price increase. So when the demand for a product is inelastic, the burden of the tax will fall on the consumer.
