Tax as a tool for government economic policy

Definition of tax
A
compulsory contribution to state revenue, levied by the government on workers’
income and business profits, or added to the cost of some goods, services, and
transactions.
Tax is an instrument for collecting revenues. It is a
major source of revenue in the developed world and has been appearing as an
important source of revenue in the developing world as well. It has been an
instrument of social and economic policy for the government.

Tax as a tool for government economic policy
Taxation
is used as a tool for government economic policy in several ways which include:
1.   
Wealth redistribution
Tax collected by the
government is expended for carrying out various welfare activities. In this
way, the wealth of the rich is redistributed to the whole community.
Redistribution of income and redistribution
of wealth
are respectively the transfer of
income and of wealth (including physical property) from some individuals to others by means of a social mechanism such as taxation. The term typically refers to redistribution on an
economy-wide basis rather than between selected individuals, and it typically
refers to redistributions from those who have more to those who have less.
Today,
income redistribution occurs in some form in most
democratic countries. In a progressive income tax
system, a high income earner will pay a higher tax rate than a low income
earner. Another taxation-based method of redistributing income is the
negative income tax.
Two
other common types of governmental redistribution of income are subsidies and
vouchers (such as
food stamps).
These
transfer payment programs are funded
through general taxation, but benefit the poor, who pay fewer or no taxes.
While the persons receiving transfers from such programs may prefer to be
directly given cash, these programs may be more palatable to society than cash
assistance, as they give society some measure of control over how the funds are
spent.
The
objectives of income redistribution are varied and almost always include the
funding of
public services. Supporters of
redistributive policies argue that less
stratified economies are more socially just.
One basis for redistribution is the concept of
distributive justice,
whose premise is that money and resources ought to be distributed in such a way
as to lead to a
socially just, and possibly more
financially
egalitarian, society. Another
argument is that a larger
middle class benefits an economy
by enabling more people to be
consumers, while providing equal opportunities for
individuals to reach a better standard of living.
2.    To cover government administrative cost
The fundamental objective
of taxation is to finance government expenditure. The government requires
carrying out various development and welfare activities in the country. For
this, it needs a huge amount of funds. The government collects funds by
imposing taxes. So, raising more and more revenues has been an important
objective of tax.
Money provided by taxation is used by government to
cover the cost of general administration process. Some of these include
expenditures on war, the enforcement of
law and public order, protection of property, economic infrastructure (roads, legal tender, enforcement of contracts, etc.), public works, social
engineering
, subsidies, and the operation of government itself. A portion of taxes
also go to pay off the state’s debt and the interest this debt accumulates.
Governments also use taxes to fund
welfare and public services. These services can include education systems, health care systems, pensions for the elderly, unemployment
benefits
,
and
public
transportation
. Energy, water and waste management systems are also common public utilities. Colonial and modernizing states have also used
cash taxes to draw or force reluctant subsistence producers into cash economies.
Taxes are applied to fund foreign aid and military ventures, to influence the
macroeconomic performance of the economy (the government’s
strategy for doing this is called its
fiscal policy).
3.      Prevent concentration of wealth in a few hands
Tax is imposed on persons
according to their income level. High earners are imposed on high tax through
progressive tax system. This prevents wealth being concentrated in a few hands
of the rich. So, narrowing the gap between rich and poor is another objective
of tax.
4. Boost up the economy
Tax serves as an instrument
for promoting economic growth, stability and efficiency. The government
controls or expands the economic activities of the country by providing various
concessions, rebates and other facilities. The effective tax system can boost
up the economy. Similarly, taxes can correct for externalities and other forms
of market failure (such as monopoly). Import taxes may control imports and
therefore help the country’s international balance of payments and protect
industries from overseas competition.
5. Reduce unemployment
The government can reduce
the unemployment problem in the country by promoting various employment
generating activities. Industries established in remote parts or industries
providing more employment are given more facilities. As a result, the
unemployment problem can be reduced to a great extent through liberal tax
policy.
6. Remove regional
disparities
Regional disparity has been
a chronic problem to the developing countries. Tax is one of the ways through
which regional disparities can be minimized. The government provides tax
exemptions or concessions for industries established or activities carried out
in backward areas. This will help increase economic activities in those areas
and ultimately regional disparity reduces to minimum.
7. To control consumption
of non essential goods
Taxes
used for this purpose are referred to as excises. They are used to modify
consumption patterns of some goods, especially non-essential goods or services.
For example, a high excise is used to discourage
alcohol consumption, relative to other goods. This may be
combined with hypothecation if the proceeds are then used to pay for the costs
of treating illness caused by alcohol abuse. Similar taxes may exist on
tobacco, pornography, etc., and they may be collectively referred to as
sin taxes“. A carbon tax is a tax on the consumption of carbon-based
non-renewable fuels, such as petrol, diesel-fuel, jet fuels, and natural gas.
The object is to reduce the release of carbon into the atmosphere. In some
countries such as the United Kingdom,
vehicle excise duty is an annual tax on vehicle ownership.
8. Reduction of inflation
When taxes are imposed on goods, consumers will
have to pay more and, therefore, it leads to an prices going up. And it should
follow that when taxes are reduced, it will reduce inflation as consumers have
to now pay less. Therefore, in the broad sense of the word, yes taxation policy
could possibly have an impact on reducing inflation.
However, the use of taxation policy to reduce
inflation is a short-term or stop-gap measure and should never be thought of as
a long-term solution. This is because, taxes on most goods are not particularly
high and the lowest you can bring taxes to is zero. Even if taxes are brought
down to zero but the prices of goods are still increasing, it may nullify the
effect caused by the lowering of taxes. Therefore, to curb inflation, it is
much better to focus on the issue that is causing the inflation than using
measures such as reducing taxes.
There is, however, a larger issue when taxes are
reduced to control inflation. Taxes, both direct and indirect, are the
lifeblood for the functioning of any government. When the government reduces
taxes on anything, it is in the process cutting down on its own income. While
economic research shows that a reduction of direct taxes (income-tax) leads to
an increase in consumption, there is no research to show that a reduction in
indirect taxes will lead to increased consumption. When a government gets less
money, then in the case of India, where the Central Government already runs a
deficit, it will have to resort to deficit financing.
9. Social security contribution
Many countries provide publicly funded retirement
or health care systems. In connection with these systems, the country typically
requires employers and/or employees to make compulsory payments. These payments
are often computed by reference to wages or earnings from self-employment. Tax
rates are generally fixed, but a different rate may be imposed on employers
than on employees. Some systems provide an upper limit on earnings subject to
the tax. A few systems provide that the tax is payable only on wages above a
particular amount. Such upper or lower limits may apply for retirement but not
health care components of the tax.
10. Protection of preferred sectors of the economy
Governments
may impose tariffs to raise revenue or to protect some sector of the economy or
domestic industries from foreign competition, since consumers will generally
purchase foreign-produced goods when they are cheaper. While consumers are not
legally prohibited from purchasing foreign-produced goods, tariffs make those
goods more expensive, which give consumers an incentive to buy domestically
produced goods that seem competitively priced or less expensive by comparison.
A variety of policies have been used to achieve these goals. These include:
·        
Tariffs:
Typically, tariffs (or taxes) are imposed on imported goods. Tariff rates
usually vary according to the type of goods imported. Import tariffs will
increase the cost to importers, and increase the price of imported goods in the
local markets, thus lowering the quantity of goods imported, to favour local
producers. Tariffs may also be imposed on exports, and in an economy with
floating exchange
rates
,
export tariffs have similar effects as import tariffs. However, since export
tariffs are often perceived as ‘hurting’ local industries, while import tariffs
are perceived as ‘helping’ local industries, export tariffs are seldom
implemented.
·        
Import quotas: To
reduce the quantity and therefore increase the market price of imported goods.
The economic effects of an import quota are similar to that of a tariff, except
that the tax revenue gain from a tariff will instead be distributed to those
who receive import licenses. Economists often suggest that import licenses be
auctioned to the highest bidder, or that import quotas be replaced by an
equivalent tariff.
·        
Administrative barriers:
Countries are sometimes accused of using their various administrative rules
(e.g. regarding
food safety, environmental standards, electrical safety, etc.)
as a way to introduce barriers to imports.
·        
Anti-dumping legislation:
Supporters of anti-dumping laws argue that they prevent “
dumping” of cheaper foreign goods that would cause
local firms to close down. However, in practice, anti-dumping laws are usually
used to impose trade tariffs on foreign exporters.
·        
Direct subsidies:
Government subsidies (in the form of lump-sum payments or cheap loans) are
sometimes given to local firms that cannot compete well against imports. These
subsidies are purported to “protect” local jobs, and to help local
firms adjust to the world markets.
·        
Export subsidies: Export
subsidies are often used by governments to increase exports. Export subsidies
have the opposite effect of export tariffs because exporters get payment, which
is a percentage or proportion of the value of exported. Export subsidies
increase the amount of trade, and in a country with floating exchange rates,
have effects similar to import subsidies.
·        
Exchange rate manipulation: A government may intervene in the foreign exchange
market
to
lower the value of its currency by selling its currency in the foreign exchange
market. Doing so will raise the cost of imports and lower the cost of exports,
leading to an improvement in its
trade balance. However, such a policy is only effective in the
short run, as it will most likely lead to
inflation in the country, which will in turn raise the cost
of exports, and reduce the relative price of imports.
·        
International patent systems: There is an argument for viewing national patent
systems as a cloak for protectionist trade policies at a national level. Two
strands of this argument exist: one when patents held by one country form part
of a system of exploitable relative advantage in trade negotiations against
another, and a second where adhering to a worldwide system of patents confers
“good citizenship” status despite ‘de facto protectionism’.
·        
Employment-based immigration restrictions, such as labour certification requirements or numerical caps on work visas.
·        
Political campaigns advocating domestic consumption (e.g. the “Buy
American” campaign in the United States, which could be seen as an
extra-legal promotion of protectionism.)
·        
Preferential governmental spending, such as the Buy American Act, federal legislation which called upon the United
States government to prefer U.S.-made products in its purchases.
11. To control balance of payment with other
countries
These are policies that a government may use to switch
consumers’ expenditure away from imports and towards home produced goods. There
are two main types – using import controls like tariffs and devaluing the
exchange rate. This is done in two different forms which are;
Import controls
If a country levies tariffs (a tax on imports) on
various imports, then their prices will rise relative to the home produced
goods and so the demand for imports should fall and switch to domestically
produced goods. This will be good for domestic producers as well as helping the
current account deficit to fall. The foreign firm could absorb the cost of the
tariff, take a cut in profits and not raise their price, but this is not a long
term solution for them. Tariffs generally cause import prices to rise.
Expenditure
reducing policies
Any government policy
designed to reduce demand in the economy and so reduce consumer spending in the
economy (and on imports in particular) falls into this category. On the fiscal policy side the government
could increase taxes or reduce public spending.
References
Avi-Yonah, S.; Slemrod, B. (2002). “Why Tax the Rich? Efficiency,
Equity, and Progressive Taxation”. The Yale Law Journal 111
(6):
1391–1416.
Johnsson, R. (2004). “Taxation and Domestic Free Trade,” Ratio
Working Papers 40, The Ratio Institute, revised June 7, 2004.
Johnsson, R. (2013). “Taxation
and Domestic Free Trade”
. Retrieved from http://Ideas.repec.org on 10th
June, 2015
Li, J. (1991). Taxation in the People’s Republic of China. New
York: Praeger.
Umale, A. A. (2013).Basic Entrepreneurship:
Theory, Management and Practice. Ughelli: Masco Graphics.

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