12 Problems with the Public Sector
12.1 The design of a tax system
Equity and Taxes
Vertical and Horizontal Equity
From: Wikipedia: Equity (economics)
In public finance, vertical equity is the idea that people with a similar ability to pay taxes should pay the same or similar amounts. It is related to the concept of tax neutrality or the idea that the tax system should not discriminate between similar things or people, or unduly distort behavior.[3]
Vertical equity usually refers to the idea that people with a greater ability to pay taxes should pay more. If the rich pay more in proportion to their income, this is known as a proportional tax; if they pay an increasing proportion, this is termed a progressive tax, sometimes associated with redistribution of wealth.[4]
From: Wikipedia: Horizontal inequality
Horizontal inequality is the inequality—economical, social or other—that does not follow from a difference in an inherent quality such as intelligence, attractiveness or skills for people or profitability for corporations. In sociology, this is particularly applicable to forced inequality between different subcultures living in the same society, i.e inequalities between culturally formed groups, not economically formed ones[1].
In economics, horizontal inequality is seen when people of similar origin, intelligence, etc. still do not have equal success and have different status, income and wealth.
Traditional economic theory predicts that horizontal inequality should not exist in a free market. However, horizontal inequality is observed in real and simulated ‘free market’ systems.
Benefit Principle versus Ability to Pay Principle
From: Wikipedia: Benefit principle
The benefit principle is a concept in the theory of taxation from public finance. It bases taxes to pay for public-goods expenditures on a politically-revealed willingness to pay for benefits received. The principle is sometimes likened to the function of prices in allocating private goods.[1] In its use for assessing the efficiency of taxes and appraising fiscal policy.
The benefit principle takes a market-oriented approach to taxation. The objective is to accurately determine the optimal amount of revenue that should be spent on public goods.
- More equitable/fair because taxpayers, like consumers, would “pay for what they get”
- Taxes are more akin to prices that people would pay for government services
- Consumer sovereignty – specific rather than general…charges are more direct…so the preferences of taxpayers, rather than government planners, are given more weight
- More efficient allocation of limited resources…it is less likely that funds will be overinvested in low priority programs.
- There’s no such thing as a free lunch – taxpayers would have a better understanding of the costs of public goods
- Provides the foundation for voluntary exchange theory.
From: Wikipedia: Theories of taxation
The ability-to-pay approach treats government revenue and expenditures separately. Taxes a