There are 5 purposes of tax. However, debates raises against this basic view of the purposes of tax. That’s the beauty of economics.
1. Tax raises revenues
Tax raises government’s revenue to fund government expenditures. This is obvious since government spending depends mostly on taxes in modern economy.
2. Tax influences behavior
Taxes may influence the way people spend and save their money. Three excise taxes designed to influence the behavior of taxpayers:
A sin tax is a significant tax on a product or service that is unhealthy. The tax is used to discourage the purchase and use of products that pose a risk to health, such as tobacco and alcohol.
The gasoline excise tax is not meant to discourage use of gasoline. It is a user tax. People who use gasoline pay taxes on it. In turn, the government spends the tax revenues on maintaining and building roads and highways and regulating underground pollution caused by gas storage.
Luxury taxes tax expensive, nonessential items. The tax requires those who buy luxury goods such as luxury cars to pay more for the goods. Revenue is then redistributed to benefit all citizens through government programs. The luxury tax is a progressive tax–it takes more from the wealthy than from the poor. The luxury tax can make certain products and services more desirable–there is a prestige in owning an item that is considered a luxury. A downside to luxury taxes is that they can be too effective. When luxury taxes become too steep, people may choose to stop purchasing a particular product. (source: irs.gov)
3. Tax redistributes income
In a progressive income tax system, people who earn high income will pay a higher tax rate than those who earn lower income. In a negative income tax, people who earn below a certain amount of money receive supplemental pay from the government instead of paying taxes to the government.
Feldstein and Vaillant argued that state and local governments cannot redistribute income. Since individuals can avoid unfavorable taxes by migrating to jurisdictions that offer more favorable tax conditions, a relatively unfavorable tax will cause gross wages to adjust until the resulting net wage is equal to that available elsewhere. The adjustment of gross wages to tax rates implies that a more progressive tax system raises the cost to firms of hiring more highly skilled employees and reduces the cost of lower skilled labor. A more progressive tax thus induces finns to hire fewer high skilled employees and to hire more low skilled employees. Since state taxes cannot alter net wages. there can be no trade-off at the state level between distribution goals and economic efficiency. Shifts in state tax progressivity, by altering the structure of employment in the state and distorting the mix of labor inputs used by firms in he state, create deadweight efficiency losses without achieving any net redistribution of income (Can State Taxes Redistribute Income? Martin Feldstein & Marian Vaillant, 1994)
4. Tax stabilizes the economy
Tax could be an automatic stabilizer in economy. During a recession, household incomes fall and the economy slows down, and government tax revenues will fall as well. Vice versa, during economic boom, household incomes rise and the economy goes up, and government tax revenues will rise as well. There is fiscal policy to stabilize economy, whether cut/raise government spending or cut/raise government revenue through tax policies or mix both spending and tax policies together. Some people agree that government should cut taxes during the bad times, then cut spending during the good times to pay it back. Doing the reverse might exacerbate the recession.
Income tax code can be altered to stabilize the economy in the face of fluctuations. First, the note suggests that tax expenditures for goods with high income elasticities should be replaced with government spending, while tax expenditures for inferior goods should be expanded. Second, income tax rates should be indexed to the growth rate of the economy, with marginal rates higher in boom periods and lower in recessions. Finally, implicit tax expenditure subsidies should be decoupled from marginal rates via the use of tax credits. All of these recommendations will enhance the stabilizing effect of the income tax in the current era of economic uncertainty. (“Stabilizing the Economy Through the Income Tax Code” Yair Listokin 2009)
5. Tax rewards “friends” and penalizes “enemies”
Politicians could use tax reform to punish their “enemies” with confiscatory taxes and reward their “friends” by inserting favorable tax breaks. Politicians could use existing tax code and do not reform the tax code if it is favorable to their “friends” or unfavorable to their “enemies”.