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Wednesday, May 02, 2012

Excess burden of Income taxes

Excess burden is the economic loss to society due to the tax enforced by the government. In other words, consumers make different choices because of the tax, and these choices may not be the best or most efficient economically. For example, the income tax lowers the discretionary income available to consumers to use in the market, therefore buying less. Producers of goods and services have to account for the taxes in their costs, causing the prices of goods to rise. Overall, these taxes decrease how many goods are produced and purchased in the market, negatively affecting the economy. It has a negative impact on the overall social welfare, because less income is being used in the market. Markets, over time, decrease poverty, and by decreasing the amount of resources and money available for the market to be used, social welfare is diminished. Also, there are the administrative costs of enforcing and collecting a tax; this is money that could also have been used in other ways that are more economically efficient and improve the overall economy.
A better alternative is using consumption tax and no income tax. A consumption tax has excess burden (all taxes do that aren’t corrective taxes), but the excess burden is smaller compared to an income tax. This means less negative impact on overall social welfare, and when people talk about changes in taxes it often is related to social welfare and trying to relieve tax burden on certain groups, such as the middle class. A consumption tax has less excess burden, therefore is better on social welfare overall.  It also addresses other social welfare concerns that often come up in discussion, such as the lack of wealth and large amounts of debt people have in the US. If consumption was taxed, rather than income and wealth, it would incentivize saving. This would increase overall wealth of US citizens, addressing another common issue discussed about the economy and social welfare. People would have more discretionary income, which would make up for the possible higher taxation of purchasing goods. In most states, we already pay sales tax so it would not be that large of an adjustment to the change. If the effect taxes have on social welfare is one of the main concerns, this would be the best approach to take.

Danielle Pierson

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