evaluate the flat tax in terms of the three criteria for effective taxes.

If supply exceeds demand, the price falls as producers try to induce more people to buy the product. The high price induces producers to make more, until supply is adequate to meet demand and the price comes down. If demand exceeds supply, the price will rise as those who want the product most compete to buy it. įree Market economies use prices to allocate resources to produce the products society wants most. Optimal taxation theory attempts to derive the system of taxation that will achieve the desired revenue and income distribution with the least inefficiency-that is, that interferes least with market participants making Pareto optimal exchanges-economic transactions that make both parties better off. Generating a sufficient amount of revenue to finance government is arguably the most important purpose of the tax system. They are (1) proportionate to incomes or abilities to pay (2) certain rather than arbitrary (3) payable at times and in ways convenient to the taxpayers and (4) cheap to administer and collect.” Tax revenue In the Wealth of Nations, Adam Smith observed that Some taxes are thought to be less distorting, such as lump-sum taxes (where individuals cannot change their behaviour to reduce their tax burden) and Pigouvian taxes, where the market consumption of a good is inefficient, and a tax brings consumption closer to the efficient level. The optimization problem involves minimizing the distortions caused by taxation, while achieving desired levels of redistribution and revenue.

However, most taxes distort individual behavior, because the activity that is taxed becomes relatively less desirable for instance, taxes on labour income reduce the incentive to work. Tax revenue is required to fund the provision of public goods and other government services, as well as for redistribution from rich to poor individuals.

The social welfare function used is typically a function of individuals' utilities, most commonly some form of utilitarian function, so the tax system is chosen to maximise the aggregate of individual utilities.

Optimal tax theory or the theory of optimal taxation is the study of designing and implementing a tax that maximises a social welfare function subject to economic constraints.

Evaluate the flat tax in terms of the three criteria for effective taxes.