Chapter 5: Macroeconomic Effects of Taxation – Key Tax Terms

Five vocabulary flashcards covering the main tax instruments and their macroeconomic effects as discussed in Chapter 5.

Distortionary Taxation

A system of taxes that creates wedges between gross factor prices (what firms pay) and net factor prices (what households receive), leading to inefficient labor and savings choices.

Lump-Sum Tax (T)

A fixed amount of tax collected regardless of income, consumption, or behavior; does not distort household decisions in the model.

Proportional Labor Income Tax (τ_l)

A percentage tax on wages that lowers the net wage received by households, thereby discouraging labor supply and distorting the consumption-leisure decision.

Proportional Capital Income Tax (τ_k)

A percentage tax on the return to capital that reduces the net rental rate, causing households to save less and distorting the consumption-savings decision.

Consumption/Value-Added Tax (τ_c)

A tax levied per unit of consumption; equivalent to a labor tax in this two-period model and distorts labor supply but, if constant over time, leaves the savings decision unaffected.