Which statement about a lump-sum tax is correct?

Which statement about a lump-sum tax is correct?

• A. Distortionary, changing incentives to produce.
• B. Non-distortionary and does not alter incentives to produce.
• C. Only affects government revenue and not resource allocation.
• D. Reduces price signals in the market.

Answer: (B)

A lump-sum tax is non-distortionary because the amount paid is fixed and does not depend on how much is produced or sold. Because it doesn’t alter the marginal cost of production or the marginal benefits of decisions, it leaves incentives to produce, invest, or work exactly as they were before. Price signals in the market come from the prices of goods and inputs, not from a fixed tax, so this tax doesn’t change relative prices or the choices producers face. It mainly affects government revenue and, through households’ budgets, overall welfare, but it does not change how resources are allocated between different uses through production decisions. The other statements either treat the tax as distortionary, which it is not, or assert effects (like reducing price signals or strictly limiting effects to government revenue) that don’t fit how a fixed tax works.

A lump-sum tax is non-distortionary because the amount paid is fixed and does not depend on how much is produced or sold. Because it doesn’t alter the marginal cost of production or the marginal benefits of decisions, it leaves incentives to produce, invest, or work exactly as they were before. Price signals in the market come from the prices of goods and inputs, not from a fixed tax, so this tax doesn’t change relative prices or the choices producers face. It mainly affects government revenue and, through households’ budgets, overall welfare, but it does not change how resources are allocated between different uses through production decisions. The other statements either treat the tax as distortionary, which it is not, or assert effects (like reducing price signals or strictly limiting effects to government revenue) that don’t fit how a fixed tax works.