It is one of the various modes used for taxation: income, things owned (property taxes), money spent (sales taxes), miscellaneous (excise taxes). It is a regressive tax, such that the lower the income is, the higher the percentage of income applicable to the tax. An example is a poll tax to vote, which is unchanged no matter what the income of the voter. Other related examples include personal property taxes on cars or business equipment regardless of income or ability to pay. Real estate taxes that are levied on a per lot or per unit basis are another example; some condominium fees could be regarded as having most of the characteristics of a lump sum tax (other than being avoidable by not owning property in a condominium).
In economic theory, a lump-sum tax is considered to be pareto-efficient because it does not interfere with optimal market mechanisms. A lump-sum tax will only reduce people's available income and therefore increase their budget constraint, but leave the relative price of goods unchanged. In basic microeconomics consumer theory, this will then lead to an income effect: consumers buy less in general (inwards shift of the budget line). There will be no substitution effect.(Hindriks, Myles, 2006)
Therefore, this form of taxation may have the advantage of not contributing to an excess burden of taxation, and loss in economic efficiency that results from taxes reducing incentives for production or consumption.
In practice, lump-sum taxes are often encountered, in spite of their conflict with other criteria, such as equity or ability to pay. A lump-sum tax remains a standard for measuring the performance of other imperfect kinds of taxes (J. de V. Graaf, 1987).
Efficient lump-sum taxes are often impossible to implement in a world of imperfect information since, to be non-distortionary, they must be levied against characteristics that individuals cannot strategically change - instead personal abilities should be taxed. For example, attempting to equalise incomes through lump-sum taxation would cause all high earners to reduce their work hours so their incomes fell to the average level. This is because any extra income would be taxed away after a certain level, if income itself were to be taxed. To be non-distortionary, the tax must be levied against something for which the individual cannot themselves change. Similarly, attempting to test innate ability through standardised exams would, again, lead to high-performing individuals deliberately performing poorly so they would receive a subsidy, rather than have some of their income taxed.
- J. de V. Graaf (1987, 2008). "lump sum taxes," The New Palgrave: A Dictionary of Economics, v. 3, pp. 251-52.
- Hindriks,J.; Myles, G.D. (2006). Intermediate Public Economics. MIT Press. ISBN 0262083442.
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