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 citizens.
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 profitable.
 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 mutual gains. 
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 philanthropist
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.

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