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Absolute Tax Incidence
Taxes will reduce the level of disposable income both at macro and micro level. At macro
level, an increase in taxes leads to a decrease in aggregate demand. If the public policy is to
stabilize the economy by increasing taxes without changing government expenditures, the
course that the economy will take will depend on distributional effect of the tax itself.
An increase in tax depending on state of the economy can lead to unemployment, a reduction
in prices or can lead in a shift in resources from one use to another use, so that each tax action
has its own effect and distribution implication. Where tax is increased or reduced without a
relative change in government expenditure or an offsetting change in other taxes the effect
that such a tax will have either in aggregate or to each individual household is called absolute
tax incidence.
Differential Tax Incidence
In some cases one tax may be replaced by another tax without changing the amount of tax
revenue and government expenditure. The effects that result from such changes in taxes are
referred to as differential tax incidences.
This form of policy change does not involve any transfer of funds from private hands to
public hands and no net burden on the private sector. It merely involves redistribution among
households. Consider a case where Kshs one billion of income tax revenue is replaced with a
cigarette excise yielding an equivalent amount. Households whose income tax is reduced will
gain, while others with high cigarette purchases will lose. Going beyond this, tobacco
growers and cigarette workers will lose, while others producing the output purchased by
former income taxpayers stand to gain. This resulting total change in the state of distribution
is what is referred to as differential incidence.
Budget Incidence
Budget incidence may originate from changes in government expenditure and changes in
taxes. Government expenditure may be on transfer payment, salaries to civil servants, capital
expenditures for development, purchases of goods and services, and debt repayment and
servicing. Incidence of government expenditure can be explained in various ways;
I) Increase in government expenditure leads to increase in disposable real income and further
increase in employment in the country. This is under normal circumstances. But, if
unplanned well,
II) Increase in government expenditure may lead to increased aggregate demand over
aggregate supply, hence leading to inflation.
On the other hand, increase in taxes has the opposite effect. Its immediate effect is a
reduction in real disposable income, increased unemployment, or reduced inflation.
NatalieR answered the question on June 22, 2022 at 05:57
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