Joseph Plazo and Andrea Trent Roundtable Taxation Effects on Emerging Economies at the Kuala Lumpur Business Summit
One of the most often discussed issues in economics is how tax rates relate to economic growth. Promoters of tax cuts promise a decrease in the tax rate will result in increased economic growth and prosperity. Others claim that if we reduce taxes, nearly all of the gains will proceed to the rich, as those would be the ones who pay the most taxes. What exactly does economic theory indicate regarding the relationship between economic growth and taxation?
Income Taxes and Extraordinary Cases
In studying economic policies, Joseph Plazo claims thatit is consistently helpful to analyze extreme cases. Extraordinary cases are situations like "What if we had a 100% income tax rate?", or "What if we raised the minimum wage to $50.00 an hour?". While completely unrealistic, they do give quite bare examples of what direction crucial economic variables will move when we change a government policy.
Joseph and Andrea suppose that the postulate. Suppose that we lived in a society without tax. We'll worry about the way the government fund its plans later on, but for now we'll assume they have enough cash to fund all the plans we've nowadays. If there are no taxes, then the authorities will not get any income from tax and citizens do not spend any time worrying about the best way to evade taxes. If a person has a wage of $10.00 an hour, they get to keep that $10.00. If this type of society were possible, we could observe that people would be quite productive as any income they make, they keep.
Now consider the opposing case. Taxes are now set to be 100% of income. Any cent you bring in goes to the authorities. It might seem the authorities would make a lot of money this way, but that is probably not going to occur. If I do not get to keep anything out of what I earn, why would I go to work? I'd rather spend my time reading or playing baseball. Actually, going to work would risk my ability to survive. I'd be a lot better off spending my time attempting to think of means to get the things I need without giving them to the authorities. I'd spend lots of my time looking to grow food in a hidden garden and bartering with others for the things I must endure. I wouldn't spend any time working to get a firm if I didn't get anything from it. Society as a whole would not be really productive if everybody spent a substantial part of the time attempting to evade taxes. The government would bring in very little income from tax, as very few folks would visit work if they did not get an income from it.
While all these are extraordinary instances, they do exemplify the result of taxes and they're useful guides of what occurs at other tax rates. A 99% tax rate is really just like a 100% tax rate, and if you discount set costs, having a 2% tax rate isn't much different from having no taxes at all. Return to the individual bring in $10.00 an hour. Can you think he will spend more time at work or less if his take home pay is $8.00 rather than $2.00? I'd bet you that at $2.00 he's not likely to spend a great deal of time at work and he's going to spend a lot of time wanting to earn a living away from the prying eyes of authorities.
Taxes and Other Ways of Financing Authorities
In the instance where authorities can finance spending beyond tax, Joseph Plazo and Andrea Trent see the following:
Productivity drop as the tax rate increases, as folks choose to work less. The higher the tax rate, the more time people spend evading taxes and also the less time they spend on more productive activity. So the lower the tax rate, the higher the value of all the goods and services created.
Government tax revenue doesn't necessarily improve as the tax rate increases. The authorities will make more tax income at 1% rate than at 0%, but they will not get more at 100% than they'll at 10%, as a result of disincentives high tax rates cause. Consequently there's a peak tax rate where government revenue is greatest. The relationship between income tax rates and government revenue can be graphed on something called a Laffer Curve.
Naturally, government programs aren't self-funding.
This contributes to the problem on tax cuts. Are tax cuts as lousy as Capitalists like to exhort?
A tax cut does not absolutely help or damage an economy. You have to consider exactly what the revenue from those taxes is being spent on before you're able to discover the result the reduction will have on the economy. From this discussion, however, we see the following general trends:
Cutting taxes and wasteful spending may help an economy due to the disincentive effect due to tax. Cutting taxes and useful plans might or might not benefit the economy.
A certain sum of government spending is required in the military, law enforcement, along with the court system. A state which doesn't spend an adequate amount of money in these areas will obtain a depressed economy. A lot of spending in these types of regions is wasteful.
A nation also wants infrastructure to really have a high amount of economic activity. Much of this infrastructure cannot be adequately provided by the private sector, so governments must spend money in this area to make sure economic growth. Nonetheless too much spending, or spending on the incorrect infrastructure can be wasteful and slow economic growth.
If folks are naturally inclined to spend their very own money on schooling and health care, subsequently tax employed for social programs probably will slow economic growth. Social spending which targets low income families is much better for the economy than universal plans.
If folks are not inclined to pay towards their particular schooling and health care, then there could be a advantage to suppling these goods, as society as a whole benefits from a healthier and well-informed workforce.
Before I get an inbox full of hate mail, I'm not suggesting that the authorities end all societal programs. There may be many benefits to these programs that aren't quantified in economic growth. A slowdown of economic growth is likely to occur as these plans are enlarged, however, so that should often be considered. When the plan has plenty of other advantages, society as a whole may wish to have lower economic growth in return for further social plans.
True this post oversimplified some essential issues. However that is normally crucial in a first look for an economic problem. I plan on dealing with some of these specific issues in more depth as time goes on. I'd love to hear your take to the issue and what you'd like to see covered in more depth later on
Joseph Plazo is an entrepreneur and lawyer in the Ateneo De Manila University. He provides pro bono consulting to local government and SMEs. Andrea Trent serves as a finance advisor in the ADB and renders bookkeeping supervision at the WHO.