Evaluating Revenue Source Public finance economists have developed several criteria for evaluating the desirability of different revenue sources. These criteria reflect the properties of a revenue source in terms of its economic efficiency, its social equity or distributional effects, its ability to provide adequate revenues, and its feasibility.
The efficiency of a tax or user charge relates to how well it allocates scarce resources. Since taxation generates market distortions by affecting the demand for and supply of goods, an ideal tax will be one whose effect on consumers and producers is small. The welfare impact of a particular tax is known as the excess burden of taxation and provides an estimate of the economic cost of raising an additional dollar of revenue. The excess burden of a particular tax depends heavily on the elasticity of demand for the taxed good with respect to its price. Motor fuel taxes are often considered an efficient revenue source, since the demand for fuel is relatively inelastic with respect to price in both the short and long run. In fact, many Western European countries have adopted rather high fuel taxes at least partly for this reason (in addition to environmental considerations). Highway tolls
Efficient taxes and user charges also are able to generate price signals which provide information to consumers about the cost of producing an additional unit of the good. Economists generally agree that efficiency can be enhanced by adopting marginal cost pricing for most goods. The concept of marginal cost pricing is particularly important in the field of transportation, where consumption of transportation services may often entail significant negative externalities. Some types of revenue sources may be able to internalize these externalities. For example, marginal-cost highway tolls may be able to internalize the external costs of congestion, while efficient fuel taxes may be able to internalize costs associated with local and global air pollution.
The issue of equity generally refers to the fairness or distributional impact of a particular revenue source across different social strata. There are many dimensions along which one can evaluate equity, but income tends to be one of the most common. Many decisions by governments about taxation policy consider the concept of ability-to-pay as a central criterion and thus involve choices about the appropriate degree of progressivity in the tax system.
Adequacy refer to the ability of a revenue source to adequately finance the system's needs over time. In practice, this means that a desirable revenue source will be one that not only grows over time to meet needs, but also one that provides a degree of stability in revenue collections, especially in the face of cyclical fluctuations in the economy.
Feasibility relates to the administrative and/or political feasibility of a given revenue source. Ease of administration is an important criterion for a good revenue source, as it implies a need for few additional resources to be expended in collecting revenue. The low collection costs and ease of administration of motor fuel taxes have often been cited as a reason for their continuing popularity among federal and state governments in the US. In contrast, tolling and direct road pricing, despite their desirable efficiency properties, often involve considerable collection costs. If their costs can be lowered in the future, these revenue sources may be more widely adopted.
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