Quota and Tax in Macroeconomics - Term Paper Example

This paper describes the widely used terms Quota and Tax in macroeconomics. This paper is divided into two parts and is structured in such amanner it defines the term quota and tax and its related terms along with the illustration of an example. The first part of this paper involves the analysis of import quota and conclusion on the analysis. Quota is a type of protectionist trade restriction that sets a physical limit on the quantity of a good that can be imported into or exported from a country in a given period of time. Quotas are used to benefit the producers of a good in a domestic economy at the expense of all consumers of the good in that economy. Critics say quotas often lead to corruption (bribes to get a quota allocation), smuggling (circumventing a quota), and higher prices for consumers. Quotas are less economically efficient than tariffs which in turn are less economically efficient than free trade.The second part of the paper involves the study of the good tax system and different types of tax systems. Tax systems are followed so as to raise money for government to pay for libraries, cleaning the roads, local parks and the local council, to create the necessary demand to resurrect the economy as the markets will not clear or sort themselves out at the right price, to force the firms to produce the socially optimal level of output as the markets themselves, will not produce the socially optimal level of output due to the problems of externalities like pollution from congestion. Keywords : Quota, Import quota, Tax, Tax systems, Good tax. Import Quota: An import quota works reduces the amount of foreign goods a country may import. The equilibrium point determines the price and quantity of a produced good. In a competitive market, this point is where the demand curve and the domestic supply curve intersect. In the case of a purely domestic market, this equilibrium point is at P* and Q* (Refer Figure). When international trade is introduced into the market, the equilibrium gets disturbed. Assuming that the price of a certain good is less than P* equal to P2 when imported from abroad. The world economy supplies more goods at that price wherein such a case, the international supply curve will be a horizontal line at P2. In this case, the equilibrium price lowers to P2 with the increase in the equilibrium quantity produced from Q* to Q4. Domestic producers will actually produce less (Q1), while the difference between Q1 and Q4 will be supplied by imports. Letting the free international trade to be introduced into the market which will enhance consumers benefit significantly. Consumer Surplus is the difference between the price that consumers pay and the price that they are willing to pay. “It is the area between the equilibrium price and the demand curve. The producer surplus is defined as the profit of the firm in the industry.” (Jean Tirole, Pg. 8). The area A indicates the consumer surplus and increases to include the areas B, C, D, E, F, G, H with the free international trade as the price to be paid is only P2 instead of P*. On the other hand, domestic producers of the good are adversely affected. The domestic producer surplus is represented by areas B, E, and J which loses the same to consumers with the international free trade as the producers can only get the price P2 for their goods instead of the price P*. Finally, the economy on the whole benefits by areas C, D, F, G, H, and I as these are not the areas of surplus before the introduction of free trade. “Because of the adverse effects of free trade on domestic producers, those producers may attempt to petition the government to enact an import quota. When this happens, the government will restrict the quantity of a good that can be imported in order to increase the price and allow producers to recover some of their lost surplus. If the government restricts total imports to the difference between Q2 and Q3, three things will happen. First, producers will increase output from Q1 to Q2. Second, imports will decline from the difference between Q1 and Q4 to the difference between Q2 and Q3. Third, the price will rise to reflect the new total quantity consumed, which is now Q3. The effect of an import quota on domestic producers is to allow them to recover the producer surplus in area E, which they take away from consumers. The effect on international producers is that they now obtain areas G and H as a surplus. The effect on consumers is that they lose E, F, G, H, and I. The effect on the total world economy is that areas F and I are lost in what is called a deadweight loss” (Mgunn, Pg. 1). The aggregate welfare is the sum of consumer surplus and producer surplus. The deviation (decrease) of aggregate welfare is measured as dead weight loss. “F represents producer surplus which is lost by goods consumed but not at a surplus to producers. I represents consumer surplus which is lost as these goods are not consumed at all. The effect on the domestic economy is that E is gained, but F, G, H, and I are lost.” (Mgunn. Pg. 1) Tax: “The only reason that a parliament was first formed in the thirteenth century was because the King at the time was short of money. He convened a meeting of some of the Lords of the time so that he could get some money from them. They, in turn, raised money from the peasants in their ‘manor’. And so tax was invented. By the time that the first book was written (in 1776) that dealt with economic issues, “The Wealth of Nations” by Adam Smith, taxation was already quite a big part of peoples’ lives. Smith discusses the ‘cannons’ of taxation. The characteristics that all good taxes should have: 1. Fairness: A tax should always consider the taxpayers ability to pay. 2. Cost: The cost of collection for the government should not be too high. 3. Convenience: It should be as easy as possible for the taxpayer to pay the tax in terms of means and timing of payment. 4. Certainty: The timing, method and amount due should be absolutely clear. There should be no excuses for tax evaders.” (S-cool Team, Pg. 1) There are lots of ways in which taxes can be categorized. Who collects the tax? (Inland Revenue or Customs and Excise). There are some taxes that neither of these bodies collects. What is being taxed? (Income, capital or expenditure). Again, there are some taxes that do not fit into any of these categories. Direct Tax: A direct tax is one that is paid directly by the individual worker or firm. Income tax is the best example. Firms pay corporation tax on their profits. “Others include Capital Gains tax, Inheritance tax, Stamp duty (paid when buying a house) and Petroleum tax (paid on North Sea Oil revenues). Technically, National Insurance contributions are a direct tax, but the Inland Revenue as with all the other direct taxes does not collect them. Officially, they are called ‘Social Security receipts’, probably because they are payments towards the state pension and other benefits that one might require in times of need.” (S-cool Team. Pg.1) Indirect Tax: An indirect tax is one that is only paid indirectly through a third party. Consumers pay Value Added Tax (VAT). For example, while buying a good or service, the retailer officially pays the tax with a rise in the price to reflect the tax. So, effectively the consumer ends up paying. Others include tobacco and alcohol duties, fuel duties (on petrol) and betting duties. Progressive Tax: A progressive tax is one where as one’s income rise; more tax is paid as a percentage of one’s income. The percentage part is important. Obviously higher income earners pay more tax than those on low incomes. Income tax is the best example of a progressive tax. “For example in UK, an unmarried earner has an allowance – he does not pay any income tax on the first £4,500. He then pays 10% on the next £1,500, 22% on the next £27,000 and then 40% (the top marginal rate of income tax) on the rest. All these figures are to the nearest 500 and are per annum earnings. These rates are all marginal, though. The point is that someone on £40,000 a year will pay more tax than someone on £20,000, but not only he will pay more actual tax, but he will pay more as a percentage of his income.” (S-cool team, Pg. 1) Regressive Tax: A regressive tax is one where as one’s income rises, the amount that is paid as a percentage of one’s income falls. A higher earner may be paying more of the tax in absolute terms but as a percentage of their income, the amount is falling. These taxes are obviously considered to be unfair as they redistribute money from the poor to the rich. The poll tax is very regressive. As stated above, whether one earned £50,000 a year or £10,000 a year, the amount paid is the same. “A £500 tax bill therefore, constituted only 1% of the high earner’s salary, but 5% of the lower earner’s salary. This is regressive and most people seemed to think this was unfair. The tax disappeared with its inventor, Margaret Thatcher. Most indirect taxes are regressive.” (S-cool Team, Pg. 1) Proportional Tax: A proportional tax is one where as one’s income rises, more tax is paid, but the amount that is paid as percentage of one’s income remains unchanged. If there are no allowances in the tax system and there is only one income tax rate of say 30%, then higher earners would pay more tax than low earners, but the amount they pay expressed as a percentage of their income would always remain the same (i.e. 30%). “Someone earning £50,000 a year would pay £15,000 income tax, and someone on £10,000 a year would pay £3,000 tax. The high earner is paying much more tax, but in both cases, the amount paid is exactly 30% of one’s income. Some economists argue that VAT is a broadly proportional tax. As one gets richer, one will spend more money. A family of four trying to survive on £10,000 a year may struggle to keep their weekly shopping bill down to £100. Couples with no children earning £50,000 a year are unlikely to spend £500 every week. In other words, as one’s income rises, one’s marginal propensity to consume falls.” (S-cool team, Pg. 1) Bibliography 1. Mgunn. Import Quota. http://en.wikipedia.org/wiki/Import_quota 2008. Page 1. 2. S-cool Team. Basic Principles of Taxation. http://www.s-cool.co.uk/alevel/economics/taxation-and-government-spending.html 2008. Page 1. 3. Jean Tirole. The Theory of Industrial Organization. Published by MIT Press. 1988. Page 8. Read More