Economics of Taxation

The economics of taxation proves to be of great use in understanding the basic rules of taxation. Taxation is believed to be a process by which certain part of the income from the businesses or households is transferred to the national government. The economics of taxation discusses on the various measures that the government applies for wealth distribution in the best possible way. The economic welfare loss can also be minimized by the proper use of taxation.

Some of the major aspects of economics of taxation are:

Deadweight costs of taxation
Double dividend taxes
Optimal taxation theory
Transparency and simplicity
Economics of tax incidence
Costs of compliance

The deadweight cost of taxation describes that the tax actually reduces the economic efficiency of a competitive market. After the implementation of tax, it can be said that the cost to the seller is actually higher than the price that is paid by the buyer. This further reduces the total volume of trade in the market. The deadweight cost depends on the supply and demand elasticity of the goods.

The economic study of the taxation says that for a market that is not perfectly competitive, the taxation can help to increase the efficiency of the economy. In case of the goods that are associated with negative externality like tobacco and alcohol, the taxation prevents too much trading of such goods in the free market. This not only increases the overall welfare of the society but also increases government’s revenue. This concept of the economics of taxation is known as double dividend.

Optimal taxation theory of the economics of taxation discusses on the various measures that the government should take up while structuring the taxation so that the deadweight cost is reduced to the minimum level.

Another concern of the economics of taxation is to maintain transparency and simplicity. It is widely believed that the complex and complicated tax codes of the developed countries actually give way to the immoral economic incentives. Hence the economists advise that a transparent tax structure wards off giving any loophole.

Economic study of the taxation says that the economic effect of taxation sometimes is not implemented at the point where it was supposed to. The taxation includes cost of compliance. For example the costs of filing out forms or keeping records of the taxation are carried by tax payers and such costs are called cost of compliance.

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Last Updated on : 1st July 2013

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