Theory question 108
Public Finance(a) What is a tax?
(b) Describe the following rates of taxation: (i) progressive tax; (ii) proportional tax; (iii) regressive tax.
(c) Explain the following principles of a good tax system: (i) equity; (ii) convenience; (iii) economy.
Show the model answer
(a) A tax is a compulsory payment levied by government on individuals and firms, for which no direct service is given in return.
(b)(i) Progressive: the rate of tax rises as income rises (the rich pay a higher percentage).
(ii) Proportional: the same rate (percentage) is charged at all levels of income.
(iii) Regressive: the rate of tax falls as income rises, so the poor pay a higher percentage of their income.
(c)(i) Equity: tax should be fair and based on ability to pay.
(ii) Convenience: the time and method of payment should suit the taxpayer (e.g. PAYE deducted from salary).
(iii) Economy: the cost of collecting the tax should be small compared with the revenue it yields.
These are Adam Smith's canons of taxation.