Tax policy

Tax policy is the choice by a government as to what taxes to levy, in what amounts, and on whom. It has both microeconomic and macroeconomic aspects. The macroeconomic aspects concern the overall quantity of taxes to collect, which can inversely affect the level of economic activity; this is one component of fiscal policy. The microeconomic aspects concern issues of fairness (who to tax) and allocative efficiency (i.e., which taxes will have how much of a distorting effect on the amounts of various types of economic activity).

Policymakers debate the nature of the tax structure they plan to implement (i.e., how progressive or regressive) and how they might affect individuals and businesses (i.e., tax incidence).

The reason for such focus is economic efficiency as advisor to the Stuart King of England Richard Petty had noted that the government does not want to kill the goose that lays the golden egg. Paradigmatic efficient taxes are those that are either nondistortionary or lump sum. However, economists define distortion only according to the substitution effect, because anything that does not change relative prices is nondistortionary. One must also consider the income effect, which for tax policy purposes often needs to be assumed to cancel out in the aggregate. The efficiency loss is depicted on the demand curve and supply curve diagrams as the area inside Harberger's Triangle.

National Insurance in the United Kingdom and Social Security in the United States are forms of social welfare funded outside their national income tax systems, paid for through worker contributions, something labeled a stealth tax by critics.

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