The Role Taxes Play In A Modern Economy Economics Essay
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Medieval economy was predominantly rural, agrarian and localized. There was very little trade from distant areas with food being based on grain and local animals. Travel was significantly localised and the middle class was emerging. Countries were controlled by the wealthy and powerful elite. The advent of the industrial revolution saw a shift of emphasis from home based industry to mechanised production and the consequent result on the social, economic and political developments in countries. Governments had to mop up resources for the expenditure on social development, infrastructure and defence resulting in the creation of tax structure to meet the requirements. Tax policies of Governments are undoubtedly linked to the state of the development of the relevant economy, be it developing or developed, and the emphasis sis thus laid on whether it has to be direct or indirect taxation which will lead to the successful achievement of government plans. Socialism and Capitalism being ideologically apart from each other have been tried and tested through the taxation methods, and though both have their benefits there appears to be a lacuna as far as successful implementation is concerned.
Critical Analysis and Discussion
A tax is a financial charge or levy imposed by a state or its functional equivalent upon a taxpayer and the failure to pay such a levy is punishable by law Taxes are imposed by a number of administrative divisions. Taxes are direct or indirect in nature and are required to be reimbursed in money or its labour equivalent.
Finances obtained through the imposition of taxation have been used by countries and their functional equivalents conventionally to carry out a number of functions. Some of these include protection of property, expenditures on war, economic infrastructure, the enforcement of law and public order, public works, subsidies, social engineering, and the very operation of the government itself. Governments utilise taxes for the funding of welfare and public services. These services include education systems, pensions for the elderly, health care systems, unemployment rehabilitation and benefits, and public transportation. Energy, water and waste management systems are also common public utilities. A portion of taxes is used alleviate the state's debt and the interest this debt accrues.
The important features of a modern economy are perceived by the efficient, fair and stable financial markets whose contribution is vital and significant for the overall financial system. The manners in which nations raise taxes are as varied as the amounts they raise. The tax patterns of a country are formulated on a number of factors as its inherent economic structure, its history, and to a significant extent on the tax structures of its neighbouring countries. Choice plays an important part, as different countries may attach different levels of importance to commonly established characteristics of a superior tax system such as fairness, required economic effects and collection costs that it entails.
The level of the per capita income is a powerful determinant of the nature of taxation a country will adopt, the higher the level of the per capita income, the more a country relies on direct taxes, particularly those on personal income. Consumption taxes although they rise more slowly tend to become relatively important in developed countries. These differentiations in tax structures reflect the basic differences between high and low income countries. Low-income countries it is observed tend to raise additional revenues at the border, as a few collection points require control. For this reason, they rely heavily on excise taxes on tobacco, alcohol and so on. In contrast, direct taxes (and VAT) require a more effective tax administration coupled with sophisticated taxpayers, these conditions are prevalent in developed countries.
Governments use diverse kinds of taxes and vary the tax rates. This helps distribute the tax burden between individuals or classes of the population implicated in taxable activities, such as business, or to reallocate resources amid individuals or classes in the population. Historically, the nobility were sustained by taxes on the poor; modern social security systems tend to support the poor, the retired, or the disabled, by taxing the working class. In addition, taxes are levied to fund military ventures and foreign aid, to substantially influence the macroeconomic performance of the economy, or to modify patterns of employment or consumption within an economy, this is done by making some classes of transaction more or less attractive.
A nation's tax system undoubtedly reflects its communal values and the values of those in power. In order to create to system of taxation, a nation is constantly confronted by choices with regard to the distribution of the tax-who will pay and how much -and the mode expenditure of the taxes collected. In democratic nations where the public elect those responsible for establishing the tax system, these choices exhibited are a reflection of the community the public wishes to create. Whilst in countries with insignificant public influence on the system of taxation, is reflective of the values of those in power on the taxation system.
Taxation thus is not just a means of financing government, but is one of the most visible parts of the social contracts underlying the state .One key reason why citizens conform with tax impositions is that they accept the state as legitimate and credible and are thus both, to some degree, eager to support it and, to some amount, afraid of what will happen if they don't. Unless states are accepted as justifiable in this sense, they will be incapable of securing sufficient resources required to govern or to develop. In this framework, the success of tax reform clearly depends upon the method by which different political groups recognize the reform and how they respond to their perception. To an important extent, then, tax reform is "an exercise in political legitimation" (Lledo, Schneider, and Moore, 2003).
In the designing of an efficient tax system, it is imperative that the issues under mentioned are taken into account.
Raising of revenue
Tax systems primarily augment revenue to fund government operations, the lack of which results in substantial budget deficits. Prevention of deficits calls for good control over both the revenue and expenditure of the government. The legislated budget ought to be structured every year to operate stringently within estimates of expected revenue receipts. Though this seems obvious, yet these initial criteria for excellent tax and budgetary policy are found wanting in a number of countries.
Tax reforms should be undertaken to attain long-term objectives. Tax systems should not be altered on a transitory basis to meet predictable current year shortfalls. Frequent tax changes result in an increase in the enforcement and compliance costs and thus increase efficiency costs.
Revenue growth usually slows during recessions while accelerating during expansions. Revenue elasticity tends to increase in expansions and plummet in recessions, thus aggravating the volatility of revenue flows. Generally, a nation that relies on a objective set of tax apparatus rather than on a single revenue resource will consequently have a lower tax revenue volatility.
Thus, a good tax system must generate sufficient revenue to fund projected government expenditures.
Taxes impose real economic costs, it is thus imperative that all countries should seek out measures to curtail such "deadweight losses," which decrease the resources accessible to achieve socially required objectives. Countries with scant resources need to espouse tax policies to help guarantee that those assets are used as resourcefully as possible. Taxes have a price tag when it amounts to collectio0n. Depending on the category of the tax, the actual charge of collecting taxes in developed nations is approximately 1 percent of tax revenues. In developing nations, the costs of tax collection could be substantially higher. Another fiscal cost is "compliance costs" that taxpayers have to bear while meeting their tax obligations, which is above the actual tax value. Tax organization and tax compliance interrelate in many ways. Finally, taxes give rise to "deadweight" or "distortion" costs. Taxes on wages reduce incentives to work. It is observed that the higher the tax rate on earnings in the formal sector, working in the formal sector is less attractive than in the untaxed informal sector. Consumption taxes also discourage work.
Good tax policy entails minimizing unnecessary expenses of taxation. In order to minimise cost, three general rules may be observed: First, tax bases must be as broad as possible. A broad-based consumption tax, for example, will still discourage work effort, but such a tax will minimize distortions in the consumption of goods if all or most goods and services are subject to tax. Second, tax duty should be low, given the revenue needs to fund government operations. The reason is simply because the efficiency cost of taxes arises from their effect on relative prices, and the size of this effect is directly related to the tax rate. Third, from an efficiency perception, it is important that careful attention be paid to taxes on production. Taxes on production have an effect on the location of businesses, modifying the ways by which production takes place, change the organisation of business practices, and so forth.
Fairness or impartiality is a vital issue in designing a tax system. and taxes exist for precisely this reason. The tax system is one such method for taking away the money from the private sector in an equitable, efficient way which at the same time is not administratively expensive.
Whilst the horizontal equity entails that those in analogous circumstances pay the same quantum of taxes. Vertical equity essentially requires that "appropriate "differences exist amid taxpayers in varied economic circumstances.
On the surface, both models have great intuitive appeal and textbook perfection, but in reality they have limited usefulness. An income tax can entirely gratify horizontal equity needs only if it is assumed that individuals comprising of tastes impossible to differentiate coupled with a single type of income or ability. Similarly, disagreement exists concerning the usefulness of the notion of vertical equity and about what composes appropriate differences in treatment. Taxes thus have an effect on equity in many and complex ways. They treat people who are in essentially in the same economic position differently (horizontal equity). Taxes also vary in their effects on income distribution (vertical equity). They may tax the rich relatively more (progressivity) or less (regressivity) than the poor.
The tax system can successfully be split into two-, with one part having its tax compliance rates very high while the second part consists of relatively low compliance rates . In order to establish the fairness of a tax system, it is essential that one take into consideration of the economic incidence of taxation. It is imperative to distinguish between those who are able to pay a particular tax as against those who reel under the negative effects or are burdened by the tax. Individuals are burdened by the tax regime in a variety of roles as producers, consumers and factor suppliers.
Determining of tax incidence necessitates a good understanding of the workings of various markets and their operational characteristics in a given economy, particularly the capability of diverse types of taxpayers to transfer the cost of the tax to other economic actors.
The finest tax policy in order to be worth its name has to possess the inherent ability to be implemented effectively. Tax policy plan ought to take into account the fundamental fact regarding the administrative facet of taxation. The resources thus consumed in the administering and complying with taxes are real economic costs, in terms of the capability of the economy to make available goods and services. Good tax strategy requires that such costs be kept as low as possible while also accomplishing revenue, growth, and distributional objectives as effectively as possible. In order to achieve this aspect, first and foremost, taxpayers have to be delineated, which entails that registration being required, the process of such registration ought to be kept as simple and easy as possible. Systems ought to be in place to categorize those, not opting to do so voluntarily. Tax authorities have to adopt a unique and apt taxpayer identification system in order to make possible compliance and enforcement.
Second, tax authorities require a process for the formulation of constituents determining tax liabilities. This might be done administratively or with the assistance of some self-assessment procedure (as with most income taxes and VATs).
Third, the taxes due are required to be collected. In many nations, this is efficiently achieved through the banking system. It is rarely appropriate for tax officials to handle funds directly.
Finally, tax authorities ought to provide adequate taxpayer service which should be in the form of information, forms, pamphlets, advice agencies, telephone and electronic filing, payment facilities, in order to ensure taxpayer compliance is as easy as possible.
Taxation and growth
It is the contention of a number of theorists that the growth curve across all economic sectors does not occur in an even fashion, due to which increased inequality is observed. Others contend that in societies in which there exists an equal distribution of resources, better performance is noticeable in the long term. Still others advocate that, regardless of what the answer may be, countries can formulate policy processes that are fully compatible with accomplishing both the objectives, namely, more growth and more equity. While the answer in all likelihood depends on a country's precise circumstances, the existing situation in many developing nations presents at least in principle various opportunities for improvement, the successful implementation of which would enable nations to have their objective of growth met successfully and at the same time indulge in redistribution with ease.
There have been numerous policy prescriptions for economic growth over the past 50 years. (Easterly, 2002). Policy advisors have, called in turn for increased capital investment, population control, improvements in education, decrease of government controls on market actions, and loan waivers, actions which were perceived as those would result in enhanced economic performance especially in developing countries. Unfortunately, not one of these cures worked as advertised.
Similarly, there exists no magic tax strategy which will enhance and encourage economic growth. It is observed that some countries endowed with high tax burdens still exhibit high growth rates and some nations with low tax burdens still continue to exhibit low growth rates. Looking at the relationship linking growth rates and tax rates in the United States over the past 50 years divulges the fact that the U.S. has had its peak periods of economic augmentation during the period where the tax rates were the highest (Slemrod and Bakija 1996).
Taxation and Decentralization
Whilst there exists no single factor by which one can determine the concept of decentralisation of tax revenues, it is possible that the extent of decentralization can be gauged in terms of the scale of local (or regional) control over these four factors: 1) Ownership of tax revenue, 2) Choice of tax base, 3) Choice of tax rate, 4) Tax administration.
Revenue ownership is an important requisite if tax revenues are to be perceived as being decentralized, but ownership alone is usually not adequate to view taxes as decentralized. The revenues are seen as a grant if local governments are endowed with revenue ownership, given that the rate, base and administration are at the state level, due to which local governments cannot be in charge of the amount of revenues raised or the means by which it is done.
While the creation of a good sub-national tax structure is even more nation-specific than the formulation of a superior tax administration, like the latter it lends itself to several generalizations. First, with regard to the local level, in most countries, more use can be made both of user charges and particularly of a simple property tax. User fees ought to be imposed wherever possible in order to finance services. They can be effectively imposed as soon as the recipients of these services are easily identified and receipt of the service can be independently acknowledged for individuals or households.
Secondly, if regional administrations are expected to play a significant role in providing nationally crucial services such as education and health, they will need access to some more key tax base such as a payroll tax or a personal income tax. The most efficient way to enforce such regional taxes is the imposition of a "surcharge" on existing national taxes, with the regional taxes being collected with the national tax - but clearly demarcated and shown to taxpayers as separate - and the remittance be made to the appropriate regional government.
Using the tax system for non-tax objectives
Policymakers could utilize the tax system in order to encourage or discourage desirable or undesirable activities. Countries are known to use tax provisions to encourage larger families, capital investment, retirement savings, , home ownership, and a multitude of other activities that are imbued or not with elements of market failures.
Policymakers have the inherent choice of implementation by subsidizing the activity directly though allowances and other programmes or indirectly, using the tax system. A number of nations make use a "tax expenditure" budget which accounts for the costs of tax provisions, used to sponsor non-tax objectives.
The results confirm that different components of government expenditures and revenues have very different impacts on development, so it cannot be simply argued that "government expenditure is beneficial for development", or that indiscriminate interventionism is to be recommended. Rather, the analysis indicates that there are some interventions by government which can be beneficial, but that governments need to plan their expenditures carefully, and to give some thought to the mode of financing to be adopted.
Policymakers have to get their policy priorities in proper perspective and exhibit the political will for the implementation of the necessary reforms planned. Tax administrations must be strengthened and fortified to accompany the needed policy changes.
With the breaking down of trade barriers capital is perceived to be immensely mobile, which calls for the formulation of as sound tax policy and this poses a significant challenge for developing countries.
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