While imposing a unique tax rate might look as a fair and logic measure, by analysing our tax system we can see that taxes on consumption are not equal across all goods. Why so?
A good point to start is to see the effect of a tax in the market where it is instituted and in the other markets. We can say that introducing a tax distorts consumption decisions and, thus, implies a dead weight loss. The market where the tax is introduced may not feel strongly the effect of its increase in price, but the other markets are also affected, since disposable income can’t purchase the same basket as before. But taxes can be used, p.e., as a way of redistribution and therefore, depending on society’s preferences, introducing a tax with a given goal may increase society’s welfare. It raises the question of whether taxes are the best way of promoting equality or if they should be avoided, an interesting question for another post.
Bearing this in mind, we should now see, for a given amount of money we pretend to collect, what should be the way we collect it (assuming, for simplicity, we collect all the money through consumption taxes): through an equal tax rate to all goods or through differenced taxes across sectors and specific goods?
I will present three cases that provide space for differentiating taxes across particular goods: i) different demand elasticities, ii) basic/superfluous goods, iii) externalities.
The first reason assumes that our aim is to minimize the total dead weight loss. Using the Ramsey rule, we know that “tax rates on goods should be inversely related to their elasticity of demand”[i], which is the same as saying goods with comparatively more elastic demands should be less taxed.
The second reason, the existence of goods that are very important to the low-income population comparing to goods that are more superfluous, seems to be straight-forward. Let’s take bread as an example. Bread is a good from each low-income families depend, for its nutritional content[ii] relatively to its price. If the price of bread goes up, these families will suffer a lot from it; on the other side, rich families will be relatively immune to it. Now suppose that instead of taxing bread, it is decided to tax jewellery. It will have an effect in the welfare of high-income families, but not on low-income ones. There’s a redistributive effect on taxing differently both goods; it depends on society’s preferences how suitable it is. This source of differentiation often enters in conflict with the previous one.
Taking into account externalities may also be a good reason to make taxes differ depending on the goods. A negative externality like pollution[iii] creates disutilities that are not considered by the consumers when buying the good; taxing it more takes in account the bad effects that the good production/consumption implies. On the other side, taxing relatively less goods that create good externalities seems to be a fair decision: we can be thinking p.e. in aiding firms that are creating synergies[iv], engaging in an active industrial policy, giving scope for future economic growth.
So, the conclusion to my initial question is that it depends. We should analyse carefully how the demand to the goods behaves, who consumes the goods we are taxing and take into account idiosyncratic characteristics of the good that are not perceived by consumers. We should though add that it is not possible to establish the theoretical ideal tax rate “panel” in the real world, due to the bureaucracy that thousands of tax rates will create, the facilitation of tax evasion, etc.
Samuel Cardoso, 624