Economic efficiency

Due to the characteristics of a market economy, an effective tax system is necessary. Although there are numerous instances to the contrary, economists often hold that markets do a reasonably effective job of making economic decisions over options like consumption, production, and finance. They believe that tax policy should, in general, refrain from influencing how the market distributes economic resources. In other words, there should be as little interference with personal choices as possible as a result of taxation.

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There should be no preference for or opposition to certain consumer spending, manufacturing methods, organisational structures, or industry sectors. Of course, this does not imply that important social and economic objectives won't occasionally take precedence over these factors. To safeguard the environment, it could be good to levy fees on pollution, for instance.

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To measure the "extra burden" that arises when taxes skew economic decision-making, economists have devised tools. The basic idea is that there is an additional burden of 20 cents if items with a value of $2 are sacrificed due to tax impacts in order to create goods with a value of just $1.80. Less distortion would be produced by a tax structure that is closer to neutral.

The concept of optimum taxation, or choosing tax laws to reduce unnecessary costs, is, therefore, a significant postwar advance in the philosophy of taxes. This theory, which deals with highly stylized mathematical descriptions of economic systems, does not provide easily implementable recommendations for policy, aside from the crucial realisation that distortions are less harmful in situations where supply and demand are not particularly sensitive to such distortions. Distributional factors have also been attempted to be incorporated into this theory. The fact that there is no wealth distribution that is based on science presents a challenge to them.

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