Question

There are many difficulties facing governments of solving equity problems without negatively affecting efficiency (for example, inheritance taxes). Find another example that illustrates this point. Point out the efficiency and the equity implications.

Answer 1

Governments often face a trade off between equity and efficiency. This is because it often seen that when government tries to achieve equity, it has a negative impact on efficiency. For instance, when government imposes a higher income tax, it will lead to a reduction in the economic efficiency but it will help in achieving equity. If they follow the progressive taxation system, it discourages people to work more and earn as a higher proportion goes as a tax.

Here, a higher tax rate is good because the revenue earned can be used to achieve equity through funding various programs which will benefit the poor sections of the society. However, this will lead to a reduction in economic efficiency because people would be discouraged to work and earn more. This will effect the productivity and production in the economy.