How to Achieve Efficiency and Equity in the Tax System

Abstract

The paper examines the efficiency and equity trade-off in the tax system. While efficiency usually recounts to how well an economy assigns limited resources to meet the needs of consumers, the goal of equity is to analyse the distribution of resources. Thus, it is related to the concepts of fairness and social justice. Efficiency deals with the optimal production and allocation of resources within the available production factors. In the tax system, efficiency means the ability to collect sufficient public revenues by making a tax system as simple as possible. Equity examines how available resources are distributed in the society. Vertical equity deals with the relative income and welfare of the population or with how equitably available resources are distributed. It may imply higher tax rates for citizens with higher incomes. Horizontal equity is based on the belief that earners with the same income should pay taxes at the same tax rate. The aim of the article is to identify those conditions under which there is no conflict between equity and efficiency in the tax system. The tax system is the government’s main lever to redistribute income, but there is a potential balance between equity and efficiency. The idea is to determine policy measures which stimulate greater equity, but have no or little effect on efficiency. In other words, our intention is to find out policy actions where equity and efficiency support each other and where tax measures may perhaps even enable a more efficient fiscal system.