1. Distribution of income

2. Direct and Indirect Taxation Direct taxes are paid directly to the tax authority by the taxpayer: –Personal income taxes: on all forms of income, i.e., wages, rental income, interest, dividends. –Corporate income taxes: on profits of firms. –Wealth taxes: on the ownership of assets. These are used to finance a variety of gov. expenditures, in contrast to –Social insurance contributions: paid by workers and their employees. They are used to finance specific expenditures: pensions, social insurance and health care. Also known as ‘earmarked taxation’.

3. Indirect taxes are taxes on spending of goods and services. They are paid by consumers indirectly through the suppliers of the good or service. –Sales taxes. In the US: fixed % of the retail price. Some goods are excluded, on the grounds of equity. In the EU: VAT, on the value added by each producer. Different rates for different types of goods and services and exceptions for some goods. –Excise taxes. On specific goods and serv: cigarettes, petrol. Split between consumer and firm. –Custom duties (tariffs). On imports of foreign goods. Levied in order to either to raise tax revuenues or to decrease imports. More important in LDCs.

4. Ability to pay principle We all agree in that individuals should pay taxes in accordance with their income or wealth: idea of fairness Aristotle distinguished between: –Horizontal equity: people who are equal wrt certain characteristics should be treated equally. –Vertical equity: people who are unequal wrt certain characteristics should be treated unequally and in proportion to their inequalities. This principle is widely accepted but there is disagreement in how it should be interpreted: normative issues.

5. Evaluation of income redistribution It is clear that some income redistribution is necessary but there is disagreement on how much is appropriate. 1.‘High taxes reduce the incentives of the rich to work and save’(proponents of supply-side policies). Negative effects on amount of labour offered and investment (and therefore capital goods formation). Counterargument: not supported by empirical evidence.

6. 2. ‘Taxes create allocative inefficiency’. Taxes are used for other objectives other than correcting market failures. In this case, they change the relative prices of goods and services and f of p, causing allocative inefficiencies. [Reason why governments levy sales taxes even though they are regressive: they do not change relative prices and therefore do not affect allocation of resources] Counterargument: greater efficiency vs greater income inequality. Morally wrong!

7. Previous arguments imply that 3. There is a trade-off between income equality and efficiency: the ++ the income equality, the ++ the inefficiency, the – the incentives faced by workers, the – the savings and investment and the – the economic growth. Counterargument: some economists argue that this is not necessarily the case. When inequalities are large, large % of the population live in poverty: low levels of educ and health, few opportunities to work → low motivation to find a job. Greater equality would provide these people with more opportunities, permitting a more efficient use of resources.

8. 4. High taxes encourage tax evasion. Two effects: it lowers amount of tax paid by the rich and tax payments become unequally distributed among taxpayers (not everyone wants to evase taxes and from those who do it, some may not succeed). Counterargument: tax evasion occurs in any case (at any income level). Scandinavian countries have some of the lowest tax evasion rates.

9. 5. Conflict between taxes as a fiscal policy tool and income redistribution. Changes in taxation for the purpose of redistributing income may conflict with fiscal policy objectives. These conflicts are unavoidable, governments have to be careful in order to avoid detrimental effects of taxation. 6. ‘Transfer payments reduce the incentives of the poor to work and save’. In particular, unemployment benefits could reduce the incentives of the unemployed to accept work. Counterargument: such a system is needed in order to offer protection to vulnerable groups needing assistance, although some may take advantage of it.