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April 14 2014


Joey Plazo and Andrea Trent Discuss Tax Effects on Emerging Economies at the Kuala Lumpur Business Summit

Among the most often discussed issues in economics is how tax rates relate to economic growth. Promoters of tax cuts assert that the decrease in the tax rate will result in increased economic growth and prosperity. Others assert that if we all reduce taxes, almost all the advantages will proceed to the rich, as those are the ones who pay the most taxes. What exactly does economic theory suggest concerning the connection between economic growth and taxation?

Income Taxes and Excessive Cases

In examining economic policies, Joseph Plazo maintains thatit is consistently useful to study extreme cases. Excessive cases are situations like "What if we had a 100% income tax rate?", or "What if we increased the minimum wage to $50.00 an hour?". While wholly unrealistic, they do give very crude examples of what direction key economic variants will transfer when we alter a government policy.

Joseph and Andrea speculate that the postulate. Suppose that we lived in a society without taxation. We'll worry about the way in which the government finances its programs later on, but for now we'll presume they have enough cash to finance most of the programs we've today. In case there are no taxes, then the authorities will not bring in any income from tax and citizens do not spend any time worrying about how to evade taxes. If a person has a wage of $10.00 an hour, they really get to keep that $10.00. If this type of society were potential, we could see that people would be rather productive as any income they make, they keep.

Now look at the opposing case. Taxes are now set to be 100% of income. Any cent you make goes to the government. It may appear that the authorities would bring in lots of money this means, but that is not likely to happen. 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 power to survive. I'd be a lot better off spending my time trying to think of strategies to get the things I want without granting them to the authorities. I'd spend a lot of my time looking to grow food in a hidden garden and bartering with others for the things I must live. I'dn't spend any time working for a company if I did not get anything from it. Society as a whole would not be quite productive if everybody spent a large part of the time attempting to evade taxes. The authorities would bring in almost no income from tax, as very few folks would head to work if they didn't make an income from it.

While all these are extreme cases, they do illustrate the consequence of taxes plus they are useful guides of what occurs at other tax rates. A 99% tax rate is really just like a 100% tax rate, and should you blow off set prices, having a 2% tax rate isn't much different from having no taxes whatsoever. Go back to the individual getting $10.00 an hour. Can you believe he'll spend more time at the office 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 planning to spend plenty of time at the office and he's going to spend a lot of time wanting to earn a living from the prying eyes of authorities.

Taxes as well as Other means of Funding Authorities

In the instance where government can finance spending outside taxation, Joseph Plazo and Andrea Trent see the following:

Productivity drop as the tax rate increases, as people choose to work less. The higher the tax rate, the more time people spend evading taxes and the less time they spend on more productive action. So the lower the tax rate, the higher the value of all goods and services produced.

Government tax revenue doesn't necessarily increase as the tax rate increases. The government will bring in more tax income at 1% rate than at 0%, but they will not get more at 100% than they will at 10%, due to the disincentives high tax rates cause. Consequently there's a peak tax rate where government revenue is greatest. The association between income tax rates and government revenue can be graphed on something called a Laffer Curve.

Clearly, government programs are not self-funding.

This results in the dilemma on tax cuts. Are tax cuts as poor as Capitalists like to exhort?

A tax cut does not absolutely help or damage an market. You must consider what the revenue from those taxes will be spent on before you are able to establish the result the reduction will have on the economy. Out of this discussion, however, we see the following general tendencies:

Cutting taxes and wasteful spending may help an economy because of the disincentive effect due to taxation. Cutting taxes and useful plans might or might not help the economy.

A specific quantity of government spending is required on the military, law enforcement, as well as the court system. A country which doesn't spend an adequate amount of money in these areas will get a miserable market. A lot of spending in these types of areas is wasteful.

A nation also wants infrastructure to have a high amount of economic action. Substantially of the infrastructure cannot be adequately provided by the private sector, so governments must spend money in this area to make sure economic growth. Nevertheless too much spending, or spending on the incorrect infrastructure can be wasteful and slow economic growth.

If people are naturally inclined to spend their own money on education and health care, then taxation used for social programs is likely to slow economic growth. Social spending which targets low income families is far better for the economy than worldwide programs.

If folks are not inclined to pay towards their own education and health care, then there can be a benefit to suppling these goods, as society as a whole benefits from a healthy and knowledgeable work force.

Before I get an inbox filled with hate mail, I am not proposing that the government stop all social programs. There can be several benefits to these plans that aren't measured in economic growth. A slowdown of economic growth is likely to occur as these programs are enlarged, however, so that should often be kept in mind. If the plan has plenty of other benefits, society as a whole may wish to have lower economic growth in return for much more societal programs.

True this post oversimplified some very important problems. However that is generally essential in a first look for an economic problem. I intend on dealing with some of these particular issues in more depth in the near future. I'd love to hear your take on the dilemma and what you'd like to see covered in more depth in the near future

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 functions as a finance adviser in the ADB and renders accounting supervision at the WHO.


Tags: payroll taxes

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