Taxation and Efficiency
The tax system influences the allocation of resources by altering such
things as the relative prices of various goods and factors and the relative
profitability of various industries. Individual taxes shift consumption and
production toward goods and services that are taxed relatively lightly and
away from those that are taxed more heavily. This alteration of market
outcomes often affects allocative efficiency.
Of course, in a world with no taxes, it would be impossible to pay for the
government programs and public goods that we desire as a society. In
practice, then, the relevant objective for tax policy is to design a tax
system that minimizes inefficiency for any given amount of revenue to be
raised. In designing such a tax system, a natural place to start would be
with taxes that both raise revenue and enhance efficiency. An example of
such a tax is the pollution emissions tax that we discussed in Chapter
17. Unfortunately, such taxes—even an economy-wide carbon tax on
GHG emissions—could not raise nearly enough revenue to finance all of
government expenditure.
In the following discussion we examine how taxes affect the economy’s
allocation of resources. We focus on the effects of expenditure taxes and
income taxes since these are the main taxes used by Canadian
governments to raise revenues.