Impact of Tax Essay Example for Free

Impact of Tax Essay Income tax is a tool to achieve economic growth in any country. Income tax is accepted not only as a means of raising the required public revenue, but also as an essential fiscal instrument for managing the economy (Burgess, 1993). Of all the taxing systems, income tax plays a major role in generation of revenue and distribution of income in any country. If income taxation is poorly designed, it may lead to fiscal imbalance, insufficient tax revenue and distortions in resource allocation that can reduce economic welfare and growth (World Bank, 1991). Hence, an ideal tax system would achieve a balance between resource allocation, income distribution and economic stabilization (Lewis, 1984). Patterns of income taxation (both in level and in composition) differ from country to country because of economic, cultural and historical factors. Ratios of tax revenue to gross domestic product (GDP) in developing countries are typically in the range of 15 to 20%, compared with 30% in industrialized nations (World Bank, 1991). It is also established that countries have different approaches to tax administration. Maisto (1988) stated that â€Å"contradictory approaches towards the subject matter have been shown by the tax authorities of different countries because of their diverging interests†. An optimal tax rate has to compromise between the state’s revenue and its economic development. A high tax rate would deter saving and development, while a lower tax rate would lead to less revenue to the state. A tax directly influences the savings of individuals and companies; it is a double edged sword used to curtail consumption activity and at the same time, allows the taxpayer to save money in different development activities (Swami, 1995). The income tax financing the current social security benefits such as health, security and provision of utilities draws heavily upon income that otherwise would have been saved. Instead of accumulating capital, this income goes to social security transfers which are probably consumed (Boadway, 1982). Bartik (1994a and b) suggested that a 10% lowering of taxes would raise employment and investment between 1 and 6%. World Bank periodically relates that economic development is directly correlated to the level of taxation, more so in developing nations where the lower marginal tax rates have higher economic growth. In addition, policy makers in these countries have a â€Å"keen interest in the elasticity of economic activity with respect to taxes, suggesting that states and regions are interested in manipulating their tax systems in an attempt to attract business or to foster growth† (Wasylenko, 1997). On the other hand, income tax rates are increased due to factors such as enormous reduction in the purchasing power of money, heavy tax erosion, urgent need for yield and dynamic public expenditure (Fossati, 1992). While dealing with the effects of income tax rates (ITR) on economic reforms, Henry and William (1996) suggested that one should evaluate the desirability of reform proposals and the impact of such reforms on individuals and businesses as a whole. They further stated that ITR change would revolve around three factors: the tax base, allowable deductions and economic development. While dealing with the ITR, it is suggested that one should study the effects created by these rates, especially the impact of ITR on economic growth (Holger, 2003). Various governments have different approaches and methods of fixing the ITR. The French Government recently introduced preferential tax treatment by reduced ITR for young innovative companies completely based on the economic growth. The scheme was originally proposed to the State by French biotechnology as â€Å"a way to rapid and strong economic growth† (European Chemical News, 2004). Martin and George (2003) analyzed several tax rates and expenditure categories and concluded that the tax system has a direct impact on the growth rate of the economy of a country. Long-term economic growth has a direct link with the country’s tax policy (John and Pamela, 2003). Fixation of ITR may be based on different systems of taxation. Akira (2003) demonstrated that a flat rate wage tax stimulated economic growth, while interest income taxation did not foster such growth. Tetsuo (2003) suggested that taxation based on environmental pollution factors results in two contradicting issues such as reduction in production and increase in tax revenue, but in the long run, this system will help the healthy economic growth for future generations. Olhoft (2003) is of the opinion that spending millions of taxpayers’ money on tax breaks and tax incentives is most likely a misguided strategy for any State when the State is in budget deficit.