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Report Thread starter 6 years ago
Hello guys,
I'm in need of help. There are 2 systems that I can choose. System 1 - VAT system. System 2 - income tax. There's a family who earns £50,000 a year, 40,000 is pension and 10,000 is income from investments. Which do you think is a better system for this family and why? If possible state why you didn't choose the other system and why.

Thank you for the help!

ps - for system 1 the avg tax is 11% and for system 2 avg tax is 28%
Badges: 17
Report 6 years ago
If your asking which system the family prefers, you need more information about the systems, you need to know the tax rates the family would be charged. The family will prefer the system where they have to pay the least tax and therefore have the most left over for themselves. Even if you knew the tax rates, you would also need to know about the families preferences for consumption vs saving since how much they would be taxed in a VAT system would depend on how my they intend to spend.

I'm not sure what you mean by avg tax but what is relevant to the family is how much their tax is.

If you are looking at the problem from the government's point of view and the question is, for a given tax revenue from the family, which system is most efficient? You could make an argument that income taxes are more efficient. Since the family's income is already determined, income taxes aren't going to impact on any decisions of the family, there is no way for the family to reduce their income in response to the tax. It is effectively a lump sum tax. However, VAT may change a families optimal savings decision. They may choose to save more to avoid the tax on consumption. This distortion creates a dead weight loss and therefore VAT is less efficient in this specific case.

So what I said first is not exactly correct, the family may not only care about which system they end up paying the most tax in. For a given tax payment, they may prefer income tax to avoid the distortion. I'm not sure this is what the question is asking though.

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