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An important feature of tax systems is whether they are flat (the percentage does not depend on the base, hence the tax is proportional to how much you earn, have, or spend), regressive (the more you have the lower the tax rate), or progressive (the more you have the higher the tax rate). Progressive taxA progressive tax or graduated tax is a tax that is larger as a percentage of income for those with larger incomes. It is usually applied in reference to income taxes, where people with more income pay a higher percentage of it in taxes. The term progresses reduce the tax burden of people with smaller incomes, since they take a smaller percentage of their income. This may be viewed as a good thing in itself, or it may be done for pragmatic reasons, since it requires less record-keeping and complexity by people with simpler affairs.
Taxes are sometimes referred to as direct or indirect. The meaning of these terms can vary in different contexts, which can sometimes lead to confusion. In economics, direct taxes refer to those taxes that are paid by the people or organizations on whom they are imposed. For example, income taxes are paid by the person who earns the income. By contrast, the cost of indirect taxes is borne by someone other than the person responsible for paying them. For example, taxes on liquor or gasoline are often included in the price of the items, so even though the seller sends the payments to the government, the buyer is the real payer. Indirect taxes are sometimes described as hidden taxes because the purchaser of goods or services may not be aware that a proportion of the price is going to the government.
In law, the terms may have different meanings. In US constitutional law, for instance, direct taxes refer to poll taxesA poll tax is a tax of a uniform, fixed amount per individual (as opposed to a percentage of income). Such taxes were important sources of revenue for many countries into the 19th century, but this is no longer the case. There are several famous cases of and property taxesProperty tax is an ad valorem tax that an owner of real estate or other property pays on the value of the target of the tax. The taxing authority performs or requires an appraisal of the value of the property, and tax is assessed in proportion to that val, which are based on simple existence or ownership. Indirect taxes are imposed on rights, privileges, and activities. Thus, a tax on the sale of property would be considered an indirect tax, whereas the tax on simply owning the property itself would be a direct tax.
The distinction can be subtle, but it is important under US law, since the United States Constitution formerly required that direct taxes be apportioned according to population. That is, if one state had twice the population of another state, then the direct tax revenue from that state must be exactly twice that from the other state. In 1895, the
US Supreme Court interpretedthe income tax as a direct tax when applied to income from property, and struck down the tax as a result. The federal government then had no income tax until the Sixteenth Amendment was ratified, which removed the apportionment requirement for income taxes.
Some economists view taxes as creating inefficiencies in the economy.
Figure 1 indicates a good without any government interference. This good could represent anything from televisions to labour. At this equilibrium quantity Q1 of the good are sold at price P1. The consumer and producer surplus are both high.
Figure 2 shows the introduction of a very simple tax. The tax charges a flat fee whenever a consumer wishes to purchase the good. The price thus rises to P2, and since fewer consumers wish to purchase the good at the higher price, the quantity produced falls to Q2. The government receives the amount of the tax for each unit sold, and this amounts to the region shown in grey. This is the amount of revenue the government receives for this tax.
Note that in this situation the price of the good to consumers only increases by half the amount of the tax, the other half of the tax is borne by the producer. Thus both consumer and producer surpluses shrink by equal amounts. For many goods this is not the case. Who bears the cost of the tax is determined by the elasticity of the good. For inelastic goods like cigarettes, and gasoline almost all of the tax is paid by the consumer.
Also note that this flat tax is extremely simplistic. Almost all taxes are a percentage of the cost of the good, many are also progressive. This is especially true with income taxes.
The tax is not a simple transfer of wealth from producers and consumers to government. A permanent loss of surplus available to society occurs, shown in orange. This inefficiency loss is often called dead weight loss or the excess burden of taxation . This shrinkage of the surplus available to society is a reason why many economists dislike taxes.
This model does not take into account what the government uses the tax money for, however, and a tax could be justified if it removes other greater inefficiencies in the economy, such as negative externalities or monopolies. In these cases a tax can be used as a tool, known as a Pigouvian tax, to reduce the inefficiency in the market.
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