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The system of taxation is used by governments in obtaining money from organizations and people. The revenue gathered from this system is used by the government to provide public services and support itself. Taxation system is relatively permanent and compulsory. It does not guarantee a direct relationship between the extent of governmental services provided to the citizen and the amount contributed by the citizen.

On the contrary, a government can still secure revenue even without the taxation system. The sources of revenue can come from the services, manufactured products, and natural resources. However, taxes are sometimes resisted by citizens because they consider it to be unfair and too onerous. Such resistance was one of the considered causes for the America Revolution.

Taxation system is also used by the government to service the national debts. In some cases, the system is also used in promoting welfare or changing the distribution of wealth or income. At a given state of public expenditures, there are microeconomic and social effects of taxation. Every combination of taxation’s various forms, there are different effects on the welfare whereas such effects may have certain common features.

In terms of economic theory, taxation system may have an income effect and substitution effects. The income effect refers to the decrease in the available resources to tax payers resulting from the transfer of resources to the government. However, in this effect, the total resources of the country or state will not be affected. On the other hand, the substitution effects may result from the reduction of the country’s resources as well. Possible cause of this effect is by making a move in lessening the productive activity.

One common feature of taxation effects in the distribution of wealth and income. The system of taxation is expected to amend the distribution of wealth and income. Vertical distribution refers to the distribution of tax among people of different levels of income while progressive tax denotes a tax that bears progressively from tax payers with higher income. Meanwhile, a tax that is the same whatever the income of the taxpayer is known as regressive. Horizontal distribution refers to the distribution of taxes among taxpayers who have the same levels of income.

The burden of taxation system is not only concentrated on taxpayers with designated income. Producers and manufacturers may able to pass percentage of their tax on their consumers through price increase. Employees are also contributors of taxes through their wages.

Taxes on employment income can also affect the demand for labor as an outcome of the tax wedge. However, the degree of effect may depend on the price flexibility in the labor market. Income tax is often used to lessen inequality by taking a percentage of the income that increases with the rising income. Corporate income tax has a disadvantage of discouraging investment by decreasing its rate of return. If equity and debt are treated differently, investment decisions are distorted and other difficulties may arise as well. Moreover, the international differences in tax treatment may also influence the location decisions most likely for multinational companies.