Tax policy

Question 1

Explain the following concepts:

1. Average tax rate
2. Marginal tax rate
3. Progressive tax
4. Linear tax
5. Regressive tax

Answer 1

1. Average: the average tax on a unit of the tax base: tax liability/tax base
2. Marginal: tax on additional unit of the tax base
3. progressive: average tax rate increases with the tax base
4. Linear tax: average tax rate is constant
5. regressive tax: average tax rate decreases with the tax base

Question 2

Requirement on a tax system 1:
Fairness
Horizontal Fairness
ability to pay principle
utility principle

Answer 2

Fairness of taxation means that the distribution of the tax burden among the citizen seems fair according to the society

Horizontal fairness: those who are the same status should pay the same tax
Vertical fairness: those who are in better situation should pay more
Ability to pay principle: tax liabilities should depend on the citizen’s ability to pay
Utility principle: tax liabilities should depend on the utility the citizens get from teh public services financed from taxes

Question 3

Requirement on a tax system 2:

Efficiency(based on deadweight loss)

Answer 3

Efficiency: the tax system should cause as little DWL as possible

Question 4

Requirement on a tax system 3:

Simplicity

Answer 4

Simplicity of tax system decrease the cost of tax administration:

• cost to taxpayers
• cost of collecting taxes

Question 5

Requirement on a tax system 4:
Flexibility
Automatic stabilizers

Answer 5

Flexibility means the ability of taxation system to adjust to changes in the economics environment
-Smoothing economic cycles(acting as a tool of countercyclical economic policy)
Automatic stabilizers:
-progressive income taxation can act as a stabilizer

Question 6

Requirements on a tax system 5:
Political responsibility
Role of inflation
Tax incidence

Answer 6

Political responsibility means that it should be clear who pays the taxes(who bears the economic burn)
Role of inflation: if tax brackets are not adjusted in a progressive income tax system in case of inflation, then with the increase of nominal incomes the average tax rates increase

Tax incidence:
the distribution of the economic burden of taxes
This distribution depends on the elasticity of demand.