Question

Consider each of the following tax policies. Decide for each whether the primary public policy goal is most likely raising revenue or changing behavior (with or without a market failure). [LO 20.1] a. Income tax. b. Cigarette tax.

Short answer

Income tax: raising revenue; Cigarette tax: changing behavior.

Step-by-step solution

Understanding Income Tax

Income taxes are generally levied on individuals and corporations to generate revenue for government spending. The primary goal is to fund public services such as education, infrastructure, and healthcare. Although income taxes can also affect behavior slightly by influencing work decisions, the main purpose is to provide necessary funds for government operations.

Understanding Cigarette Tax

Cigarette taxes are often imposed with the dual intention of generating revenue and discouraging the consumption of cigarettes due to their health risks. The primary behavior-focused goal of this tax is to reduce smoking rates and improve public health. By making cigarettes more expensive, the tax serves to deter smoking behavior, especially among price-sensitive groups like teenagers.

Identifying Primary Public Policy Goals

For income tax, the primary goal is raising revenue to support government functions. For cigarette tax, while it does raise revenue, the primary goal is changing behavior to address the market failure associated with the negative externalities of smoking, by reducing cigarette consumption and improving public health.

Key concepts

Income Tax

Income tax is one of the main ways governments collect money. It is a mandatory financial charge imposed on individuals and corporations. The main goal of income tax is to raise funds that the government can use to improve public services. These services include education, healthcare, and infrastructure.

By taxing earnings, governments can redistribute wealth throughout the economy. This helps to fund vital projects and ensure high-quality services for citizens. While income tax can influence work behaviors and decisions, its major purpose is to support government functions.

• Essential for funding public projects
• Used to support schools, hospitals, and roads
• Can have a slight impact on how individuals plan finances

Cigarette Tax

The main purpose of a cigarette tax is a mix of raising revenue and changing behaviors. Cigarette taxes are levied to reduce smoking by making cigarettes more costly. This reduces the accessibility and appeal of cigarettes, mainly among young people and those with limited incomes.

Governments impose this tax to combat the negative health effects associated with smoking. With higher prices, fewer people are likely to start smoking, and current smokers may be more inclined to quit. This leads to better public health and fewer resources spent on treating smoking-related illnesses.

• Aims to reduce cigarette consumption by increasing prices
• Improves public health results
• Helps lower healthcare costs over time

Market Failure

Market failure happens when the allocation of goods and services is not efficient. This usually means that the free market is unable to distribute resources equitably. Cigarette smoking is a classic example of market failure due to its negative externalities.

Smoking affects more than just the smoker. Second-hand smoke and increased public healthcare costs are burdens for society. By imposing a cigarette tax, governments aim to correct these failures. The goal is to lower the social costs created by smoking. This tax can lead to more balanced resource distribution and improved public welfare.

• Occurs when markets do not allocate resources efficiently
• Can be corrected with interventions like taxes
• Helps reduce societal costs from negative externalities

Behavioral Economics

Behavioral economics explores how psychological factors affect economic decisions. It challenges the traditional economic belief that people always make rational choices. In the context of taxes, such as cigarette taxes, behavioral economics plays a crucial role.

Cigarette tax leverages the concept of price sensitivity. Higher cigarette prices can deter smoking, making it costlier to maintain the habit. This is especially true among groups like teenagers who are more responsive to price changes.

• Examines the impact of psychological factors on economic decisions
• Shows how taxes can be used to change consumer behavior
• Highlights the importance of considering how people actually behave