The ability to pay principle is the belief that those with the greatest ability to pay taxes should pay more than those with less ability to pay. This concept is known as vertical equity—people with different levels of income should be treated differently. The progressive federal income tax is a good example.
The benefits received principle means that the individuals receiving the benefits are those who pay for them, as with gasoline taxes. However, the principle does not work well for public goods, because it is not possible to find out who benefits and by exactly how much.
Global Watch: Big Winner of World Series of Poker: The Tax Man
There is also and administrative burden of taxes such as the income tax, which leads to another deadweight loss, which would be lower with a flat rate tax.
Taxes and subsidies can be efficiency enhancing when used to correct externalities, as with “sin taxes.”
Policy Issue: A Consumption Tax?
Use What You’ve Learned: The Burden of the Corporate Income Tax
9.3 Public Choice
When the market fails, as in the externality or the public good case, it may be necessary for government to intervene and make public choices. However, it is possible for government intervention to make matters worse.
Public choice theory is the application of economic principles to politics. Public choice economists believe that government actions are an outgrowth of individual behavior. They assume that the behavior of individuals in politics, like those in the marketplace, will be influenced by self-interest. Bureaucrats, politicians, and voters make choices that they believe will yield them expected marginal benefits that are greater than their expected marginal costs.
The private sector and the public sector differ in the "rules of the game" they must follow. But the self-interest assumption is central to the analysis of behavior in both arenas.
Scarcity and competition are present in the public sector, as well as in the private sector.
Exhibit 1: Do People in Government Waste Tax Money? 1970-2004
In private markets, there is an individual-consumption-payment link, where the goods one gets reflects what one is willing to pay for. The link breaks down when goods are decided on by majority rule. If the majority decides that certain goods will be provided, people will have to purchase the goods through higher taxes, whether they value the goods or not.
In two party systems, the candidate with the most votes wins the election. Because voters are likely to vote for the candidate that holds views similar to theirs, the candidates must pay close attention to the preferences of a majority of voters.
A successful campaign would have to address the concerns of the median voters, resulting in moderate policies. The candidate that takes the median position is less likely to be defeated--the successful candidate will seek out the median voters.
Exhibit 2: The Median Voter
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