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Tuesday, January 22, 2013
Taxation and Pareto Optimality
In most democratic institutions, taxation has often garnered
heated political debates among political stalwarts simply because each party
would like to see the final results to be in its favor. Since American
proclamation of independence in 1776, the history of taxation has remained an
issue of contention and debate such that the topic has become the most
important subject of discussion. Governments are obliged to enact taxes by
raising revenue and that revenue is one that comes from the pockets of
Buyers and sellers find it problematic and unbearable when a good is
taxed by the government. Because tax on a commodity affects price and quantity,
it is the forces of supply and demand that share the burden of taxation.
Depending on the amount of taxation, levying a tax on buyers sends the demand
curve downwards. Thus, taxation
undermines the financial capability of buyers and sellers.
Akin to the concept of efficiency, Pareto optimality was coined or
developed by an Italian economist by the name Vilfredo Pareto (1848-1923). Efficiency
appears in various definitions though its precise meaning is when one
experiences the desirable effect of a product while using minimum effort or
expense. Efficiency is best realized when conducted in a manner that is reciprocally
According to Stiglitz (1987),
beginning in the 1930s, a tremendous waning of taxation was experienced after
the advent of the new welfare economics. Due to imperfection of information on
the part of the government, taxation becomes distortionary. Trade-off leads to
equity and efficiency. According to Hyman (2011) there is freedom associated
with advantageous exchanges. This in turn elevates the aspect of efficiency and
Building a Park Financed by an Increase in the Local Property Tax
Building a park that is financed by an increase in local property
tax may not be a bad idea as it benefits the public that surrounds it. Children
will come and play, parents and relatives will feel relief from work and home
related stress by just sitting on the grass and the benches or making a walk
through the woods, while a section of society would gather around to
commemorate special occasions. However, as per the Pareto efficiency, because
the park will benefit a few as many may not have the time for leisure, we could
assume that many of the home owners who foot the tax will become financially
burdened. Therefore, constructing a park through increase in local property tax
is not Pareto Efficiency.
Building a Park Financed by a Rich
It is a good gesture when a philanthropist builds a park for his
community. The philanthropist is displaying generosity and care for fellow
citizens who are in need of a place to relax during their spare times. People
living around the park will not be affected financially since they don’t have
to pay tax on the land and the newly constructed park. Likewise, the city will
not be subjected to financial constraints and that its coffers will not be
affected by the construction of the park. Thus, it could be argued that the
park project is a case of Pareto Improvement.
Lung Cancer Financed out of General Revenues.
Financing lung cancer can be a good initiative because many who
suffer from lung cancer will get medical attention and the companies that
manufacture lung cancer medication will increase production. Establishing a
lung cancer institution means many sufferers will get treatment while those who
don’t recover will still get the right attention. New doctors and nurses will
be hired and dispatched to the facility. Jobs will be created and there will be
supply and demand. So, this is Pareto Improvement.
Medical Care Facilities for Lung Cancer Financed by Cigarette Tax
I think we will not see Pareto Efficiency by building more medical
care facilities through cigarette taxation. While the smoker will be affected
by the taxation, the medical care facilities will create more opportunities for
society and that unemployment will drop. To attain Pareto Efficiency, everyone
in society must benefit from the medical care facilities. Unfortunately, it is
the smoker who will be left financially burdened by the taxation.
Stiglitz, J.E. (1987). Pareto efficient and
optimal taxation and the new new welfare economics. Working Paper No. 2189. Cambridge, MA:
National Bureau of Economic Research.
Hyman, D.N. (2011). Public finance: A contemporary application of theory and policy. Thousand Oaks, CA:
Sage Publications, Inc.