The presence of externalities favors ________ and the presence of other distortionary taxes favors ________.

Question

Quizplus · Accepted Answer

Externalities are market failures that occur when the actions of one party affect the well-being of another party without compensation. Nonneutral taxes are taxes that are not levied at the same rate on all goods and services. The presence of externalities favors nonneutral taxes because they can be used to correct for the market failure. For example, a tax on pollution can be used to discourage firms from polluting, which can improve the well-being of others. The presence of other distortionary taxes favors nonneutral taxes because they can be used to offset the distortions caused by the other taxes. For example, a tax on income can be used to offset the distortions caused by a tax on capital.

The Presence of Externalities Favors ________ and the Presence of Other