CHAPTER 15: The Effects of Taxation and Spending on Inequality and Poverty
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and in part by acting to correct for market failures. The latter category includes efforts to check the power of monopolies, provide public goods such as defense and basic research, and tackle negative externalities such as air pollution. The second role of government is to maintain macroeconomic stability, for instance, by keeping inflation low and moderating the business cycle of boom and bust. Third, governments have a role to play in enhancing equity, although the extent to which they should do this is controversial. Incidence analysis only measures the effects of government spending and revenues on the equity dimension. Such information is an essential input into informed decision making, but there is no reason to expect it to be the only determinant of the way spending and taxes are, or should be, structured.
Review Question 1. Incidence analysis measures who benefits or loses, and by how much, from government spending and taxes.
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True False Uncertain
Presenting Incidence Results The basic idea behind benefit or tax incidence is to determine how much each person gains from government spending or loses because of taxes paid. The distribution of these gains or losses can then be compared with a reference distribution— such as income or consumption per capita—to determine the degree of progressivity of the spending. Suppose that we have successfully identified how much each person in our sample pays in, say, personal income tax (PIT). We now need to present the results in a clear and compelling way. The simplest approach is to tabulate the results by quintile (or decile). This is illustrated in table 15.1 for some hypothetical numbers. Column (2) sets out the mean income of five groups of individuals, sorted from poorest to richest; the share of each in total income is shown in column (3). Now suppose that the mean tax payments per person are those shown in column (4). In column (5), we compute the tax paid as a percentage of income. In this example, the proportion of income that goes to pay the tax rises as income rises, and so the tax is considered to be progressive. This may be seen in another way. The figures in column (6) show that the proportion of total tax paid by the poorest group (4 percent) is less than its share of total income (6 percent), and that this situation reverses as one moves to the higher-income individuals.
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