Tax systems Essay Example | Topics and Well Written Essays - 1750 words

Tax systems - Essay Example Indirect taxation leads to income effect. Income effect occurs when people find that they have surplus money and therefore their demand for goods and services increase. In case of no tax levied people after earning certain amount of income will start preferring leisure over work. Since indirect taxation increases the prices of goods and services people will have to work harder to keep up their standard of living and will have to earn more income to buy the same â€Å"basket† of goods that they were buying before and this will lead to more working hours in the economy. In this case, increase in taxation would result in increase in incentives for people to work hard and to expend more effort.ii) Regressive Taxation system is one where rich people pay lesser proportion of their income as tax than the poorer people. For example, a flat tax of $5 would make a higher proportion for someone earning $100/month than someone earning $200/month. For someone earning $100/month it would be 5%, whereas for the other guy it would be 2.5%. This kind of tax system is normally regressive and usually indirect taxation is regressive. On the other hand progressive system is one where rich people pay higher tax than the poor people. Income tax is usually progressive as it takes into account the income of people. Regressive taxation can be an incentive for people to work hard and earn more money, whereas as progressive systems can be a disincentiveSince regressive system leads to same amount of tax in absolute terms for both rich and poor., any additional work or money earned by poor people would reduce their proportion of income as tax. This makes people work harder to nullify the effects of regressive tax. For example, if someone is earning $100 and he knows that he will have to pay $5 in taxes every time irrespective of his income. He would try to increase his income to $105 to nullify the effects of the tax. This increase in income for $100 to $105 will increase his dispos able income after tax from $95 to $100. The person by earning more would be $5 richer. Hence, regressive tax system encourages increase in effort. People work harder to increase their disposable income to improve their standard of living. Progressive system can be a disincentive to work harder. Since, progressive tax increases with the additional income earned, many people would be put off from working harder as they will think that any increase in