Tax
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Taxation
An aspect of fiscal policy
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By country
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Total revenue from direct and indirect taxes given as share of GDP in 2017[1]
A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an
individual or legal entity) by a governmental organization in order to fund government spending and
various public expenditures.[2] A failure to pay, along with evasion of or resistance to taxation, is
punishable by law. Taxes consist of direct or indirect taxes and may be paid in money or as its
labour equivalent. The first known taxation took place in Ancient Egypt around 3000–2800 BC.
Most countries have a tax system in place to pay for public, common, or agreed national needs and
government functions. Some levy a flat percentage rate of taxation on personal annual income, but
most scale taxes based on annual income amounts. Most countries charge a tax on an
individual's income as well as on corporate income. Countries or subunits often also impose wealth
taxes, inheritance taxes, estate taxes, gift taxes, property taxes, sales taxes, payroll taxes or tariffs.
In economic terms, taxation transfers wealth from households or businesses to the government. This
has effects that can both increase and reduce economic growth and economic welfare.
Consequently, taxation is a highly debated topic.
Contents
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1Overview
2Purposes and effects
3Types
o 3.1Income
o 3.2Social-security contributions
o 3.3Payroll or workforce
o 3.4Wealth
o 3.5Property
o 3.6Goods and services
o 3.7Tariff
o 3.8Other
o 3.9Descriptive labels
o 3.10Fees and effective
4History
o 4.1Trends
o 4.2Forms
5Economic effects
o 5.1Incidence
o 5.2Increased economic welfare
o 5.3Reduced economic welfare
6In developing countries
o 6.1Key facts
o 6.2Summary
7Views
o 7.1Support
o 7.2Opposition
o 7.3Socialism
o 7.4Choice
o 7.5Geoism
8Theories
o 8.1Laffer curve
o 8.2Optimal
o 8.3Rates
9See also
o 9.1By country or region
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10References
11Further reading
12External links
Overview[edit]
Pieter Brueghel the Younger, The tax collector's office, 1640
The legal definition and the economic definition of taxes differ in some ways such as economists do
not regard many transfers to governments as taxes. For example, some transfers to the public
sector are comparable to prices. Examples include tuition at public universities and fees for utilities
provided by local governments. Governments also obtain resources by "creating" money and coins
(for example, by printing bills and by minting coins), through voluntary gifts (for example,
contributions to public universities and museums), by imposing penalties (such as traffic fines), by
borrowing, and also by confiscating wealth. From the view of economists, a tax is a non-penal, yet
compulsory transfer of resources from the private to the public sector, levied on a basis of
predetermined criteria and without reference to specific benefit received.
In modern taxation systems, governments levy taxes in money; but in-kind and corvée taxation are
characteristic of traditional or pre-capitalist states and their functional equivalents. The method of
taxation and the government expenditure of taxes raised is often highly debated
in politics and economics. Tax collection is performed by a government agency such as the Ghana
Revenue Authority, Canada Revenue Agency, the Internal Revenue Service (IRS) in the United
States, Her Majesty's Revenue and Customs (HMRC) in the United Kingdom or Federal Tax
Service in Russia. When taxes are not fully paid, the state may impose civil penalties (such
as fines or forfeiture) or criminal penalties (such as incarceration) on the non-paying entity or
individual.[3]
Purposes and effects[edit]
The levying of taxes aims to raise revenue to fund governing or to alter prices in order to affect
demand. States and their functional equivalents throughout history have used the money provided
by taxation to carry out many functions. Some of these include expenditures on economic
infrastructure (roads, public transportation, sanitation, legal systems, public safety,
education, health-care systems), military, scientific research, culture, and the arts, public works,
distribution, data collection and dissemination, public insurance, and the operation of government
itself. A government's ability to raise taxes is called it's fiscal capacity.
When expenditures exceed tax revenue, a government accumulates debt. A portion of taxes may be
used to service past debts. Governments also use taxes to fund welfare and public services. These
services can include education systems, pensions for the elderly, unemployment benefits, and public
transportation. Energy, water and waste management systems are also common public utilities.
According to the proponents of the chartalist theory of money creation, taxes are not needed for
government revenue, as long as the government in question is able to issue fiat money. According to
this view, the purpose of taxation is to maintain the stability of the currency, express public policy
regarding the distribution of wealth, subsidizing certain industries or population groups or isolating
the costs of certain benefits, such as highways or social security.[4]
Effects of taxes can be divided into two fundamental categories:
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Taxes cause an income effect because they reduce purchasing power to taxpayers.
Taxes cause a substitution effect when taxation causes a substitution between taxed goods and
untaxed goods.
Substitution effect and income effect with a taxation on y good.
If we consider, for instance, two normal goods, x and y, whose prices are respectively px and py and
an individual budget constraint given by the equation xpx + ypy = Y, where Y is the income, the slope
of the budget constraint, in a graph where is represented good x on the vertical axis and good y on
the horizontal axes, is equal to -py/px . The initial equilibrium is in the point (C), in which budget
constraint and indifference curve are tangent, introducing an ad valorem tax on the y good (budget
constraint: pxx + py(1 + τ)y = Y) , the budget constraint's slope becomes equal to -py(1 + τ)/px. The
new equilibrium is now in the tangent point (A) with a lower indifferent curve.
As can be noticed the tax's introduction causes two consequences:
1. It changes the consumers' real income (less purchasing power)
2. It raises the relative price of y good.
The income effect shows the variation of y good quantity given by the change of real income. The
substitution effect shows the variation of y good determined by relative prices' variation. This kind of
taxation (that causes the substitution effect) can be considered distortionary.
Budget's constraint shift after an introduction of a lump sum tax or a general tax on consumption or a
proportional income tax.
Another example can be the introduction of an income lump-sum tax (xpx + ypy = Y - T), with a
parallel shift downward of the budget constraint, can be produced a higher revenue with the same
loss of consumers' utility compared with the property tax case, from another point of view, the same
revenue can be produced with a lower utility sacrifice. The lower utility (with the same revenue) or
the lower revenue (with the same utility) given by a distortionary tax are called excess pressure. The
same result, reached with an income lump-sum tax, can be obtained with these following types of
taxes (all of them cause only a budget constraint's shift without causing a substitution effect), the
budget constraint's slope remains the same (-px/py):
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A general tax on consumption: (Budget constraint: px(1 + τ)x + py(1 + τ)y = Y)
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A proportional income tax: (Budget constraint: xpx + ypy = Y(1 - t))
When the t and τ rates are chosen respecting this equation (where t is the rate of income tax and tau
is the consumption tax's rate):
the effects of the two taxes are the same.
A tax effectively changes the relative prices of products. Therefore, most economists,
especially neoclassical economists, argue that taxation creates market distortion and results in
economic inefficiency unless there are (positive or negative) externalities associated with the
activities that are taxed that need to be internalized to reach an efficient market outcome. They have
therefore sought to identify the kind of tax system that would minimize this distortion. Recent
scholarship suggests that in the United States of America, the federal government effectively taxes
investments in higher education more heavily than it subsidizes higher education, thereby
contributing to a shortage of skilled workers and unusually high differences in pre-tax earnings
between highly educated and less-educated workers.
Taxes can even have effects on labor supply: we can consider a model in which the consumer
chooses the number of hours spent working and the amount spent on consumption. Let us suppose
that only one good exists and no income is saved.
Consumers have a given number of hours (H) that is divided between work (L) and free time (F = H L). The hourly wage is called w and it tells us the free time's opportunity cost, i.e. the income to
which the individual renounces consuming an additional hour of free time. Consumption and hours of
work have a positive relationship, more hours of work mean more earnings and, assuming that
workers don't save money, more earnings imply an increase in consumption (Y = C = wL). Free time
and consumption can be considered as two normal goods (workers have to decide between working
one hour more, that would mean consuming more or having one more hour of free time) and the
budget constraint is negatively inclined (Y = w(H - F)). The indifference curve related to these two
goods has a negative slope and free time becomes more and more important with high levels of
consumption. It's because a high level of consumption means that people are already spending
many hours working, so, in this situation, they need more free time than consume and it implies that
they have to be paid with a higher salary to work an additional hour. A proportional income tax,
changing budget constraint's slope (now Y = w(1 - t)(H - F)), implies both substitution and income
effects. The problem now is that the two effects go in opposite ways: the income effect tells us that,
with an income tax, the consumer feels poorer and for this reason he wants to work more, causing
an increase in labor offer. On the other hand, the substitution effect tells us that free time, being a
normal good, is now more convenient compared to consume and it implies a decrease in labor offer.
Therefore, the total effect can be both an increase or a decrease of labor offer, depending on the
indifference curve's shape.