5 Tax Flashcards
Lump-sum tax
A tax that is the same amount for every individual, regardless of income or wealth. Lump-sum taxes are efficient because they do not distort behaviour but are inequitable as they disproportionately affect low-income individuals.
Distortionary taxes
Change economic behaviour by altering incentives
Direct vs. indirect taxes
Direct taxes are levied directly on individuals or organizations, such as income or corporate taxes. Indirect taxes are applied to goods and services, such as sales or value-added taxes (VAT).
Economic incidence
Who ultimately bears the buden of the tax, depending on price elasticities of supply and demand. Eg. cigarettes addictive and inelastic hence consumers bear burden. Vs luxury car purchase can be foregone
Average vs marginal tax rate
average tax rate is the total taxes paid as a percentage of total income. The marginal tax rate is applied to the last dollar of income earned, influencing labor and investment decisions
Inequality
uneven distribution of income, wealth, or opportunities among individuals or groups within a society
Gini coefficient
Measure of inequality, ranging from 0 (perfect equality) to 1 (maximum inequality). It is calculated by comparing the cumulative distribution of income or wealth to perfect equality (represented by the Lorenz curve)
Measures of inequality
- Lorenz Curve
- Gini coefficient
- 90:10 ratio
- Share of income of top 1% of earners
Vertical equity
principle that individuals with higher incomes should pay more in taxes, ensuring fairness in tax systems
Social Welfare Function
tool to evaluate social outcomes, balancing equity and efficiency by aggregating individual utilities. A utilitarian SWF focuses on maximizing total welfare, while other SWFs may prioritize reducing inequality
Ramsey Rule
Minimizes the deadweight loss of a commodity tax system while raising a fixed amount of revenue
Rule: To minimize distortions, goods with inelastic demand or supply should be taxed more heavily than those with elastic demand or supply
The optimal tax causes every good to have the same proportional reduction in compensated demand
- broad tax base rule (meaning it’s better to tax a wide variety of goods at a moderate rate than a few at a high rate)
- an inverse elasticity rule: when elasticity of demand for a good is high it should be taxed at a low rate (and vice versa)
Limitations to Ramsey rule
- Customers care about their own individual welfare not social welfare
- Those with less elastic demand may need the good more
- Regulators may limit the ability to adopt Ramsey prices
Optimal income taxation
A framework for designing tax schedules that balance equity (redistribution) with efficiency (minimizing economic distortions)
Progressive taxation
Higher-income individuals pay a larger percentage of their income, reducing inequality
Lump Sum
A single tax rate applied to all incomes. Are very efficient (it is very complicated for you to change your behaviour to evade it)
But simple, flat taxes are less equitable. Example: The UK Poll Tax (Community Charge) required all adults to pay the same fixed amount, regardless of income