Public Economics Unit 1- Revenue Source

6th Semester

what is a tax?

A tax is a compulsory payment made by individuals to the government without direct return, used for financing public goods and government expenditure.

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Why are taxes imposed?

Taxes are imposed to:

1. Finance public expenditure

2. Provide public goods

3. Reduce inequality

4. Stabilize the economy

What are the basic characteristics of tax?

• Compulsory payment

• No direct benefit to taxpayer

• Paid to government

• Used for public purposes

Direct Tax vs Indirect Tax

Direct tax

• A tax imposed directly on a person’s income or wealth and cannot be transferred to another person.

• Example:
  Income tax, wealth tax, property tax.

• Burden- The same person who pays the tax bears the burden.

• It is non transferable

• Nature- Direct tax is generally progressive in nature, meaning tax increases with income.

• Rate of tax- Based on income

Indirect Tax

• A tax imposed on goods and services which can be shifted from producer to consumer through prices.

• Example:
  GST, customs duty, excise duty.

• Burden- The tax burden can be shifted to consumers through higher prices.

• It is transferable

• Nature- Indirect taxes are usually regressive, because everyone pays the same tax regardless of income.

• Rate of tax- same for everyone

What is Lindahl taxation?

Lindahl taxation is a system where each individual pays a personalized tax price equal to their marginal benefit from a public good.It represents the efficient provision of public goods where everyone pays according to their benefit.

• Condition which determines Lindahl equilibrium

P=MB

Price of public good = Marginal benefit to individuals.

• Total demand for public goods is derived in Lindahl taxation Through vertical summation of individual demand curves.

what are the Principles of Taxation?

1.Benefit Principle of Taxation- This principle states that taxpayers should pay taxes according to the benefits they receive from government services.

Example
People using highways pay road taxes.

Lindahl Model (Lindahl Taxation)

Proposed by Erik Lindahl.

The idea is that each individual pays a tax price equal to their marginal benefit from public goods.

Condition of Lindahl Equilibrium

Efficient provision occurs when:

Sum of Marginal Benefits = Marginal Cost

Limitations of Benefit Principle

1. Difficult to measure benefits.

2. Public goods are non-excludable.

3. Rich people may receive more benefits.

4. Free rider problem.

2.Ability to Pay Principle- This principle states that taxes should be levied according to a person's ability to pay rather than benefits received.

Measures of Ability to Pay

1. Income

Most common base of taxation.

2. Wealth

Assets owned by individuals.

3. Consumption

Total spending by individuals.

Higher income individuals have greater economic capacity, therefore they should pay more taxes.

Horizontal and Vertical Equity

Horizontal Equity

Individuals with equal ability to pay should pay equal taxes.

Example
Two people earning ₹5 lakh should pay the same tax.

Vertical Equity

Individuals with greater ability to pay should pay higher taxes.

Example
Someone earning ₹20 lakh should pay more tax than someone earning ₹5 lakh.

Importance of Equity in taxation

• Ensures fairness in tax system
• Reduces inequality
• Increases social welfare

what is federal finance?

Federal finance studies the division of financial powers and responsibilities among different levels of government.

It is also called Fiscal Federalism.

Levels of Government

1. Central Government

2. State Government

3. Local Government

Each level performs different functions.

Objectives of Fiscal Federalism

1. Efficient allocation of resources

2. Decentralization

3. Better public service delivery

4. Regional development

what are the Fiscal Functions?

1. Allocation Function

Providing public goods.

2. Distribution Function

Reducing income inequality.

3. Stabilization Function

Maintaining economic stability.

Intergovernmental Transfers

Intergovernmental transfers are financial transfers from higher levels of government to lower levels.

Example
Central government giving funds to state governments.

Reasons for Transfers

1. Reduce regional inequalities

2. Support local governments

3. Improve public service delivery