Introduction

A well-known and well-accepted policy of the government is to tax the rich and provide welfare benefits to the poor who cannot sustain minimum acceptable standards of living consistent with human and social dignity. Although such a practice is in vogue in all countries in the world, the quality and quantity of intervention varies widely. Governments may use current taxes and borrowing to finance its activities, including provisions for transfer of payments. The recipients of transfers generally constitute that group of people who do not pay direct and indirect taxes of various kinds, as may be prevalent in the economy. While indirect taxes are user taxes and, therefore, everybody has to bear it regardless of income level, it should not be restrictive to assume that the transfer recipients either consume a small amount leading to generation of smaller tax revenue, or they consume goods and services that are outside such tax nets. Regarding the use of inputs, it is also unlikely that such individuals engage in purchase of raw materials and hiring of labor that would attract indirect taxes. In fact, individuals from poor households in several countries depend on subsidized food grains, fuel, and public services. This could apply equally well for the public distribution system in India to allocation of food stamps in the United States. Services availed in public hospitals and subsidized public transports are mostly exempt from the payment of indirect taxes.

Therefore, the purpose of this chapter is to remind us that if transfer payments made out of taxes lead to escalation of unskilled wages in the labor market and if tax payers are forced to hire non-tax-paying workers for certain household activities, effectively there will be double taxation. The double taxation operates first through a higher tax rate implemented directly and indirectly, and thereafter through the higher wage rate of non-tax-paying workers, as propelled by public transfer programs. Ignoring the general equilibrium effect of this phenomenon reflects an incomplete and imprecise economic judgment.

The example that we consider is true for households in many developing countries, but if we expand this limited example to the case of home production in general, then following Becker (1965) allocation of time for such activities remains a much more generic subject.