Neutral Taxation System - Essay Example

A NEUTRAL TAX SYSTEM Introduction Taxation of savings has an important role when you consider hoe economists evaluate tax systems. These savings are taxed for five reasons; first, it directly affects the tax base thus the term comprehensive income tax. Secondly, it is an important determinant of the extent to which tax system recognizes interpersonal differences in lifetime income, as opposed to annual income. Furthermore, it equalizes the tax burden. The third reason is that taxation of savings is the boundary between the taxation of personal income and taxation of company profits. Fourth, savings taxation can affect both the total amount of savings in the economy and how these savings are allocated across assets. Lastly, for individuals, the taxation of savings affects the decision on savings and when to allocate their assets. This system of taxation has a lot of impacts to the communities involved and has numerous recommendations. Generally, the whole issue is tied on people’s general saving behavior. Every time a taxation system surfaces people tend to adjust their saving behaviors. This is just normal because taxes play an important role is asset finance. Widely, we tend to save less when our incomes are low and needs are high (Buguignon 2005, 39). Therefore to save one cannot rely on an income to save. We save or run down our existing wealth when the amount for consumption differs from the amount of income they receive in a particular time period. The present paper addresses precisely these issues and suggests a normative framework to analyze tax policy in which social preferences are concerned by individual utilities instead of the ambiguous concept of ‘household welfare’. Individual level data are rare and even more difficult is the measure of individual welfare so that we resort to the use of a structural multi-utility model with minimalist assumptions regarding preferences. Moreover, social evaluation of welfare - at individual or household level – requires the formal framework of the optimal taxation theory. This way, the paper suggests one of the very first attempts to reconcile two branches of the economic literature which are usually dissociated. On the one hand, we benefit from the collective model of labor supply (Chiappori, 1988, 12) which acknowledges explicitly the presence in the household of several deciders whose preferences may differ. The decision making process - the incentive constraint of the social planner - relies on the sole Assumption that household decisions are Pareto-efficient. This setting allows studying the intra-household distribution of resources and welfare. On the other hand, the normative evaluation of tax-benefit policies is possible thanks to an explicit modeling of the equity-efficiency trade-off faced by the planner. In the model of Mirrlees (1971), the level of productivity is unobservable and instead of taxing talents, the planner must target labor income, which is observed but depends on productive behaviors (second-best). Even though the model has raised great interest in the 1970s, only general results have been derived regarding the properties of an optimal tax system (Atkinson 1976, 32). More precise characterizations are not possible unless one is ready to make very crude assumptions on the various ‘ingredients’, when implementing the model, or on the structure of the tax system (flat marginal tax rates). In the recent years, the use of micro data combined with tax-benefit micro simulation programs has contributed to the revival of this literature and has raised new questions (Bourguignon and Spadaro 2002, 53). The implementation of the optimal tax model requires among other things the knowledge of social preferences and individual preferences. The issue of social preferences can be seen as a subject of research per se. In principle, it is possible to derive the optimal tax schedule for different values of the social aversion to inequality and identify the level for which the optimal schedule coincides with the actual one. From the saving behavior study we learn that two distinct concepts of neutrality matter with respect to the taxation of savings. The first is the neutrality over the level and timing of saving. “The tax system is neutral in this sense; it does not distort people’s choice over when to consume their income”. The second is neutrality between different types of savings vehicles or assets. Taxing the normal return to savings means taxing consumption tomorrow more heavily than consumption today. In some contexts, having different tax rates on consumption according to when it occurs is conceptually rather like having different tax rates on different forms of consumption. It might appear that taxing savings is effective ways to redistribute—after all, aren’t people with large savings wealthy almost by definition? But someone with savings is not necessarily better off over their lifetime than another person without savings. The two might earn and spend similar amounts over their lifetimes, but at different times: one earns his money when young and saves it to spend when he is old, while for the other the timings of earning and spending are close together. Taxation can be done directly on the total resources through a person’s money at its source (Atkinson and Stiglitz, 1976). Broadening the tax base to include savings might seem like it allows us to reduce tax rates on earnings and reduce disincentives to work. But work decisions involve trading off consumption against leisure. If someone is working in order to finance future consumption, then taxing savings—reducing the future consumption that can be bought with earnings—discourages work just like taxing earnings directly. Why discourage work more among those who prefer to consume the proceeds later? Also, the productivity of agents is assumed to be unobservable insofar as it does not coincide with their wage rate (calculated as earnings divided by working time). In effect, several authors have emphasized the fact that work duration is only one aspect of the labor supply decision (Terrington 2008, 29). The overall productive effort which generates observed income may well be related to other unobservable dimensions such as intensity of work, mobility, learning effort, etc. This limitation to the traditional model of labor supply is often recalled, in particular in the optimal taxation frame work where it serves to justify that productivities are unobservable. Yet, this dimension is rarely exploited in empirical works on taxation and receives special attention here. The necessary reinterpretation of the labor supply model implies a somewhat symmetrical approach to the econometric one as preferences are assumed to be known while exogenous productivity of each spouse must be retrieved by inversion of the house hold program at its optimum. To simulate household behaviors, we posit a very simple bargaining rule whose only virtue is to allow a reasonable depart from the equal sharing assumption. Two regimes of individual preference are chosen in order to obtain low and high levels of responsiveness of productive efforts, giving the upper and lower bounds in line with the literature for married men and women separately. We explore the sensitivity of the results to these various levels of elasticity. However, there are alternative ways to undertake these taxes. A comprehensive income tax cannot take us to a savings-neutral system of taxation. But there is in fact more than one route to a savings-neutral system. We consider three here. In doing so, and in order to facilitate the discussion, we find it very useful to make use of some simple notation. We describe each stage in the life of the asset in which savings are invested as taxed (T) or exempt from tax (E). However, these forms have varied implications for the tax treatment of returns in the excess of normal returns as well as for time of government revenue. The normal return is the main concept. It can be obtained by holding savings in the form of a safe, interest-bearing asset. For this reason, it is often called the normal risk. This system If context does matter, should this be exploited when planning taxes? If distraction means that the goose does not notice the feathers being plucked, should we use this device to reduce the hissing? Or should the government seek to make taxes more apparent? This brings us to the normative basis for the Review, where there are several distinctions to be drawn and these could usefully have been made more explicit. The first is between outcomes and process (Jackson 2011, 52). Outcomes appear in the social welfare function, but process often features prominently in debates about taxation. One of the major arguments made in the Review for the integration of personal income tax and social security contributions is that of transparency. This is a judgment about process — one that I find quite appealing. In contrast, the argument in favour of integration on grounds of administrative simplicity is an argument in terms of outcomes: the cost savings would raise social welfare. In that case, we have to consider the different ways in which outcomes can be assessed. We may decide to focus on individual well-being, but this does not necessarily mean experienced utility. For many years, most recently in The Idea of Justice, Amartya Sen has argued for considering alternative evaluative bases, notably individual capabilities, defined broadly as the freedom that people have to function in key dimensions. Well-being assessed in terms of capabilities may lead to different conclusions. Moreover, outcomes may be evaluated according to other criteria than well-being. A good example is gender equality. Taxes and transfers can contribute, either manifestly or latently, to reducing gender inequality. This is not considered in the Review, but influences our judgments about a number of the proposals discussed. The within-household distribution of income may be affected by the balance between direct and indirect taxation. Extending VAT to food may leave worse off those in the household who do the grocery shopping. When considering the income-testing of child benefit, we have to remember that an express intention of the legislation was to aid women by making the benefit payable to the mother in the first instance. The Review set out ‘to identify reforms that would make the tax system more efficient, while raising roughly the same amount of revenue … and while redistributing resources … to roughly the same degree. Our motivation [is] to unlock significant potential welfare gains’ (p.2). Their ‘vision of a good tax system’ to achieve this objective includes a progressive income tax, exempting the ‘normal return to savings’, with a coherent rate structure, a single integrated transfer system for those with low incomes or high needs, a largely uniform value-added tax (VAT), with additional taxes on alcohol, tobacco and road congestion, a lifetime wealth transfer tax, and a single rate of corporation tax, exempting the ‘normal return on investment. Indeed, the Meade and Mirrlees reports have much in common. Both take a broad view of the issues and are firmly grounded in economic theory. Both review teams have blended the contributions of senior scholars with those of up-and-coming younger researchers. Both demonstrate the value in this politically-sensitive field of an independently financed inquiry. There are also important differences. One is scale. The report of the Meade Committee was contained in one volume; the Mirrlees Review has produced two substantial volumes with a total of 1,880 pages — nearly a quarter of the length of UK primary tax legislation (Amos 2008, 32). A second important difference arises from the fact that public economics has moved on. The Mirrlees review rests heavily on empirical findings, reflecting the revolution in public finance achieved through intensive use of micro-data and the development of micro-econometric techniques. The two volumes produced by the Mirrlees Review provide valuable policy analysis and demonstrate the vitality of modern public economics. They are worthy successors to the Meade Report and represent a new landmark in the field. At the same time, my reading of the three topics considered here (just three of many covered by the Review) is that public economics has tended to become separated from other branches of economics (such as industrial organization and labour economics) — and from other disciplines (such as moral philosophy and psychology). It risky is being too narrow in its approach and, by focusing the analysis too sharply, missing important parts of the story. Bibliography MIRRLEES, J. A. (2008). Tax by design: the Mirrlees review. Oxford, Oxford University Press. JAMES, M. (2009). The UK tax system: an introduction. London, Spiramus. MAHR, B. (2007). Comparison of US, UK and German corporate income tax systems with respect to dividend relief. München, GRIN Verlag GmbH. http://nbn-resolving.de/urn:nbn:de:101:1-201008228595. BOURGUIGNON, F. (2005). Are we on track to achieve the millennium development goals?: [sixth Annual World Bank Conference on Development Economics in Europe was held in Brussels, Belgium, on May 10 - 11, 2004]. Washington, DC, World Bank [u.a.]. Bourguignon, F. & Spadaro, A., 2002. "Social Preferences Revealed through Effective Marginal Tax Rates," DELTA Working Papers 2000-29, DELTA (Ecole normale supérieure) Atkinson and Stigz. Indirect Taxation and Redistribution: The Scope of the Atkinson and stigs .. (1976) DIXON, P. B., & JORGENSON, D. (2012). Handbook of Computable General Equilibrium Modeling SET, Vols. 1A and 1B. Burlington, Elsevier Science. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=1073029. AMOS, T. (2008). Human resource management. Wetton, Cape Town, Juta. JACKSON, S. E., SCHULER, R. S., & WERNER, S. (2011). Managing human resources. Mason, Ohio, South-Western. TORRINGTON, D., HALL, L., & TAYLOR, S. (2008). Human resource management. Harlow, Financial Times Prentice Hall. Read More