Wednesday, July 13, 2011

Increasing Taxes on the Wealthy Not A Panacea (Part II)

At the end of my previous post, I asked what should be taxed instead of luxury goods or services.  If a tax must be levied on a population (for whatever reason), ideally, it will be efficient.  That is, the tax will cause the least amount of deadweight loss (foregone economic activity) in society.  Generally, the most efficient tax is a lump-sum tax.  Why?  Look at what a lump-sum tax does to your incentive to purchase goods and services.  Can you avoid the tax?  No.  Does the tax make you substitute away from one good towards another?  No.  So, none of society’s resources are devoted to avoiding the tax.  You just pay it because you exist.

Margaret Thatcher toyed with implementing a “Head Tax” in Britain during the 1970’s.  It was met with strong resistance.  People found the idea of being taxed for literally having a head repugnant.  But, the tax was efficient, it would have caused the least amount of damage to society (did not distort incentives, did not cause deadweight loss) when compared to other taxes.  

Is there anything like the “Head Tax” in the United States?  Well…not exactly.  But, we do have an income tax.  While we do not get taxed for being alive, we do get taxed for trying to make that life enjoyable and not poverty-ridden.  However, as I’ll explain later, we still get a bit of deadweight loss associated even with an income tax, especially at higher levels of income.  

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