5.2.4—Taxation

Taxation is a compulsory payment to government. Direct taxes are charged on income or wealth; indirect taxes are charged on spending or transactions. Taxes can raise revenue, redistribute income and change incentives.

The legal payer is not always the person bearing the economic burden: tax incidence depends on the relative elasticities of demand and supply. A tax can also create deadweight loss if it prevents mutually beneficial trades.

A per-unit tax on a product shifts supply upward; if demand is relatively inelastic, consumers bear more of the price increase, while the government receives the tax revenue.

A progressive tax schedule is not the same as an indirect tax, and raising a tax rate does not guarantee proportionally higher revenue if behaviour changes or the tax base shrinks.