Question

Answer the questions briefly.
(a) What is double dividend effect?
(b) Consider two possible tax schemes on natural resources. One levies fixed fee per production amount (for example, per barrel for oil and per tones for iron ore) while the other
levies fixed percentage on total revenue. Which one is better in terms of flexibility and
why?
(c) Does income taxation satisfy horizontal equity? Explain why or why not.
(d) If we want to maximize the tax revenue while minimizing the reduction of quantity
traded in a competitive market, should we use unit tax or ad valorem tax? Explain

Answer 1

(a.) The double dividend effect is used to describe tax rates which is not efficient. Such inefficient tax rates creates distortions in the economy. Inefficient tax rates effect consumer, labor and others by reducing their real returns. The double dividend effect indicates that, reduction in such inefficient tax rates, would eliminate such distortions and generate more revenue with more efficient tax rates.

(b.) Given the, two possible tax schemes on natural resources. One levies fixed fee per production amount and other levies fixed percentage on total revenue, Fixed fee per production amount (for example, per barrel for oil and per tones for iron ore) is better in terms of flexibility. Because, The government can change tax rate at any point of time more easily as compared to tax levies fixed percentage on total revenue. When government required more revenue it can change tax rate according to the prevailing situation.

(c.) Yes, income taxation satisfy horizontal equity.

Explanation

According to Horizontal equity, when the individuals have same level of income,the necessarily be taxed at equal tax rate. The income tax is applicable to all the individuals who have income more than a certain level of income. Therefore, income taxation satisfy horizontal equity.

(d.) If we want to maximize the tax revenue while minimizing the reduction of quantity traded in a competitive market, We should use ad valorem tax. It can easily be understand by the following diagram:

Ad valorem tax Unit tax Price Price TAX TAX Qt Q1 Qt Q1 Quantity Quantity