Question

3. Recently, the economic advisers of the Government have favored the establishment of a food tax to increase its taxable income. This may occur since the demand for food consumption is inelastic. How does this approach show the trade-off between efficiency and equity in a market economy? How can this type of tax be favored or not?

Answer 1

The trade off between equity and efficiency can be explained by the Engel's law given by Ernst Engel. The law states that as the income increases, consumption expenditure in proportion to income falls. The reason for this is quite clear. The consumption expenditure is a fixed expenditure for everyone and hence there will not be much variation in food consumption because of income. Hence, it is unfair for the government to charge food tax as there will be no equity. Both the rich and the poor will be charged uniformly. Even though, this tax would be efficient as more tax would be collected since everybody consumes food.

This tax should not be favored if the government wants to have more equity in the system. However, since political parties in market economies usually overlook equity, it is possible that the political parties would prefer this policy as it will result in more money collected in forms of taxes and they can put this money to other constructive purposes.