Costs of Taxation in the USA - Dissertation Example

Costs of Taxation Introduction Taxation is considered as the most important source of revenue for the government however, it is also being criticizedfor its affects on the economy. A higher tax incidence is believed to be not only reducing the disposable income of the individuals but it also effects the businesses in general. The various welfare costs associated with the taxation therefore are often considered as having the value eroding impacts of taxation on the businesses as well as on the individuals. The range of costs related with the taxation not only includes the costs of compliance, administration, avoidance but it also includes the cost of rent seeking. Further, the cost of welfare is also a significant issue which need to be addressed specially in terms of capital appreciation.(Feldstein, 1978). The creation of deadweight losses is also another important area related with the costs of taxation which need further analysis and exploration in order to closely analyze all the implicit and explicit costs associated with the taxation. Deadweight losses are important because they create economic inefficiencies as people shift from the high value economic activities to activities which may not return the desired value. This is also critical due to the fact that revenue generated by the Government by raising the tax revenue and its subsequent spending must have to be compared with the deadweight losses that taxation creates as a result of its implementation and levy on the businesses as well as on the general public. This question will therefore effectively deal with and explore the costs associated with the taxes and will provide a comprehensive overview as to how such costs can be minimized. This discussion therefore will draw evidence from theory as well as practical examples Taxation Taxes are the most important source of revenue for the government and it is through this source that Government raises most of its revenue for subsequent expenditure. Taxes are generally raised either through direct taxation or indirect taxation on the businesses and households. Direct taxes are imposed directly on the firms and households such on their income or profits whereas indirect taxes are often collected by firms on behalf of the Government from households. Examples of indirect business taxes include sales taxes, duties etc. The most obvious reason as to why Government raises taxes is to collect the revenue to not only funds its expenses on the general administration of the government spend but also spend the same on the development of infrastructure as well as on the things like social security, health, defence, policing as well as education. As such taxes allow government to perform its most basic responsibilities as the caretaker of the State.(Boadway, Marceau & Mongrain, 2007). However, there are also some costs associated with the taxation and advocates of classical economics often oppose the imposition of taxes as they are believed to be interfering the with market forces. This general belief is therefore rooted into the philosophical stance that the markets shall be left alone to work on their own without the interference from the Government. Taxes therefore are seen as the sort of interference by the government into the overall affairs of the market and the costs related with taxes are given serious consideration while making credible economic analysis. Costs of Taxation The debate over the costs of taxation and the concepts related with the justice in taxation is one of the oldest debates in this regard. Even Adam Smith discussed the issue of taxation and the responsibilities of the government to run the State in most optimal manner. (Weiner, 2010). However, as the issue became more prominent and the complexities of the economy grew stronger, it became obvious that the costs related with the taxation may be important factor while assessing the benefits of imposing taxes and their subsequent collection by the Government. Recent literature has also focused on the marginal welfare costs of the taxation by ignoring the earlier adapted methodology of assessing the costs associated with the taxes which tend to take lump sum taxes into account. In fact marginal excess burden is created by taking into consideration the incremental welfare costs that will be incurred as a result of increasing the tax revenue by one dollar. (Ballard, et. al 1985). Studies conducted by Ballard, Shoven & Whalley (1985) indicated that the overall welfare loss from raising the tax revenue by one dollar is significant due to the existing taxes. Thus most of the studies focused on the assessement of the welfare loss related with the increase in the tax revenue along with other explicit and implicit costs that individuals and firms have to incur as a result of the imposition of the taxes. Deadweight loss occur due to inefficiencies in the market caused by various reasons. Introduction of taxes is also considered as one incidence or source of creating deadweight loss in the economy due to resulting inefficiency due to increase in taxes. Deadweight loss is a type of allocative inefficiency as at equilibrium level both the goods and services may not be pareto efficiency. A higher deadweight loss therefore require that any future expenditures to be incurred by the government as a result of increase in the taxes shall outweight the costs associated with them. This means that the benefits of such expenditure shall be greater than the deadweight losses created as a result of the imposition of additional taxes. Further, the impact of the marginal increase in tax revenue can be more signficiant where the elasticities of the labor supply and the savings are higher. When taxes are increased, the overall disposable income of labor goes down therefore making it less attractive for the labors to supply their services for the jobs. As a result the labor supply started to systematic decrease if the the marginal impact of new taxes are higher. A lower labor supply therefore can result into the reduction in the production and growth rates. There are two broader areas in which costs of taxation can arise. These three areas include cost of raising the government revenue, the loss resulting from the consumer as well as producer surplus as well as the cost of administrating the tax system and laws as a whole. Administrative and Levying Costs Probably the most important cost associated with the taxation is the administrative as well as levying costs. This is most significant cost because it requires a large machinery of government officials to collect the tax and perform the tax assessment tasks as outlined by Robson (2007). Further the cost of compliance of the tax codes and laws existing within the country may be one of the most expensive endeavors for the government as Government machinery may require significant resources to collect and ensure compliance with the existing laws and regulations pertaining to tax collection and accounting within the country. Further, there are costs associated with the compliance is also an issue not only from the social perspectives but from the perspective of the cost also. People have to approach their tax consultants and solicitors in order to prepare their tax return and to ensure that they do not violate the laws. Further, they have to interact with the tax officials that invariable create trouble and sometimes oppression of the individuals as claimed by Robson (2007). Administrative costs are significant because they can often result into inefficiencies as people responsible for the collection of taxes may not be efficient in collecting the taxes and as such there may be misallocation of required resources. Deadweight Losses Resources are optimally allocated when it becomes impossible to “make one person better off without making someone else worse off.”(Nicholson, 2004). As such the resources become misallocated if assets are utilized in most efficient manner as their inefficient utilization will create the chances of improvement and without making anyone worse off. Probably the most important aspects of the costs associated with the taxes is the creation of deadweight loss which is resulted after the loss in the consumer as well as producers surplus. When taxes are levied consumers generally tend to pay more than what producers receive and in that process a deadweight loss is created which invariable put the resources of the economy to inefficient utilization. This also means that the inefficient utilization of the resources of the economy will create misallocation of the assets and too many resources may be spent on unproductive work. “Dead-weight costs of taxation go unnoticed, even by those who pay them, because instead of taking from people what they already have, they take from people what they would have had, but never get” as quoted by Lee (2007). He also cites that “No one sees the extra value that would have been created by economic decisions that would have been made without taxes.” Lee (2007) also outlined that “ the problem here is similar to the one that governments create, and take advantage of, with tax withholding. When taxes are deducted directly from our paychecks, few of us pay much attention to just how much we are paying. Indeed, people often get excited when they overpay their taxes through withholding and get a refund at the end of the year. The tax withdrawals were hardly noticed (and neither is the interest lost because the government had the money), but the refund is obvious and seems to be a gift from the government” (Lee, 2000). The above quote indicate that the deadwight losses go often unnoticed and as such the losses or the costs that society as a whole bear as a result of the imposition of new taxes. What is also significant to note that the creation of deadweight losses arrest the resources of the economy and as such it becomes difficult for the firms and households to free up the resources that have been potentially eaten up by the imposition of new taxes. What is also however, important to note that the higher taxes often result into lesser national debt. If a country is able to raise higher taxes, its reliance on the debt to fill up its budget deficits will be low. Furthe higher tax collection may also result into the budget surpluses which invariablly create more welfare for the economy as a whole rather than creating costs. Studies have shown that the countries where taxes are higher, the overall welfare is high as compared to the countries where taxes are low. As Brooks & Hwong (2006) indicate that most of the welfare states of the world are those states where the taxes rates are really high however, government in return often provides most of the basic and fundamental facilities such as education as well as health at no cost to their citizens. How to minimize such costs? In order to minimize such costs, it is important that a more fiscal discipline is brought into the economy. The cost of administrating the tax system can be controlled and further reduced by automating the tax collection system so that the firms and individuals do not have to interact with complicated bureaucratic hurdles in order to pay their taxes. This will also create strong motivation for the households and firms to pay their taxes because cost of avoidance will be low and paying taxes can become a cheaper affair. Further, this will also make tax collection system more efficient and easier to use with individuals and firms finding it easier to assess their taxes and pay them off with relative ease.(Rabushka & Veldhuis, 2008). Further, the benefits associated with the collection and spending of taxes shall be higher as compared to the costs. When benefits become higher, the overall arguments for higher tax costs become insignificant because the revenue generated by the government is directly or indirectly spent on the citizens without any discrimination. Conclusion Taxes are most important source for the government to raise its revenue and it is important that the government must raise revenue to a level where it does not have to be dependent on the external sources to fund its day to day activities. It is critical to note that less or no collection of taxes may render government ineffective in terms of providing the necessary and essential services such as health, education and safety. Government can only achieve this by generating its own revenues by charging taxes on the households as well as the firms. However, there are certain costs which are associated with the taxes including the social as well as monetary costs. Social costs may include the relative troubles that individuals and firms may face while communicating and interacting with the tax officials. Further the costs of compliance can be relatively higher for the people if the tax collection system is not essential efficient in nature. Imposition of taxes also creates deadweight losses because both the consumers as well as the producers lose as a result of the imposition of the new taxes. The deadweight loss associated with the taxes therefore may result into the inefficient allocation of economy’s assets into unproductive uses which invariably put more pressure on the economy. It is however, important to note that the imposition of taxes put less pressure on the government to borrow from the external world. Higher taxes result into higher tax revenue for the economy which means low budget deficits and low debt levels. Cost and Benefit Analysis of Dam Project Introduction Though the term cost benefit analysis can be used in multiple contexts however, within the context of economics, it is mostly referred to the welfare economics and its impacts on the general public. On the more general front it is also associated with the maximization of wealth as compared to the maximization of the utility in terms of evaluating the public sector projects. As Posner(2000) claims. The cost benefit analysis therefore indicate towards the evaluation of the projects in order to make a credible assessment of the investments made and the benefits that could be generated from the use of resources on such public projects. As Divewert (1983) cited that cost benefit analysis can also be performed within the context of general equilibrium model as the impacts are assessed before and after the introduction of the project. Divewert however, is of the opinion that the process of computing the welfare effects of the introduction of new projects can be difficult to assess. This also means that the cost benefit analysis needs to be performed in such a manner that it can offer the ease of calculation besides providing a clear and concise description of how the introduction of the proposed project can create significant public welfare. In its essence, cost benefit analysis is the process of comparing the costs of a project with that of the benefits generated by the project. As such what is also critical to understand that the cost benefit analysis ratio must be compared with the alternatives available and can be taken in place of the proposed project? In a sense, cost benefit analysis is more or less similar to the investment analysis which considers the benefits of the project with that of the costs and discounts the same at an appropriate discount rate. Cost benefit analysis and the factors required to assess whether a project is worthwhile include the assessment of social benefits, assessment of the tax burden as well as the access to technology and information besides undertaking the review of valuation techniques such as NPV and IRR while at the same time determining the appropriate discount rate. In this question, the factors which can be considered while performing the cost benefit analysis of the proposed project will be discussed besides shedding light on the choice of appropriate discount rate. Factors to be considered Cost Benefit Analysis One of the most important aspects of the cost benefit analysis of public projects is their ability to create welfare for the general public. The proposed project will be utilized for the generating of electricity as well as other utilities essential for the society to utilize its economic resources in most optimal manner. What is also however, critical to understand that while analyzing the associate social benefits of the proposed projects, it is important that a comprehensive analysis of the costs must also be evaluated along with the benefits. It is important to note that while performing the cost benefit analysis, it is important to take the incidence of the taxes on the proposed project. The cost factor therefore take into consideration the impact of the taxes as the government often finance its projects through raising the taxes. The impact of increased taxes therefore will ultimately fall on the households and firms therefore it is critical that the tax factor shall be incorporated into the analysis. Different factors which can be considered for the evaluating cost benefit analysis are: Social Benefits Public projects are often undertaken after diverting the funds from other projects therefore it is important that such diversion must be on merit. This therefore means that the proposed public project must provide the required social benefits otherwise the selection of such projects may result into the welfare loss rather than the welfare gains for the general public. As Brown & Jackson (1990) point out that any project whether under the private or public ownership always creates a systematic stream of consumption benefits therefore social benefits shall be viewed within this perspective. Thus the most significant factor that needs to be considered is the potential social benefits which may be derived from the development of the propose project. This project will be resulted into the generation of electricity, irrigation water as well as the water supply. Though these benefits may be of significant social value however, their cost and benefit need to be compared before making any decision. Assessing Tax Burden Government can only finance its projects either through raising the new taxes or through borrowing from the general public. Both the options have their own relative merits as well as de-merit and must be considered into account while proposing any project. As Boisever & Mapp (1974) discuss that it is important to understand that before making a comprehensive effort to analyze a project from the perspective of cost-benefit, it is important to asses the proper tax burden of the project on the families if government wishes to finance the project by raising the taxes. Scale of Project and Timing of Investment Deciding on the size and scale of the project as well as the appropriate timing for the investment are important criteria to be met. As Harberger et. Al.(2007) points out that deciding the scale of project will help to determine as to how the Government can take up the technological constraints that may be put due to the scale of the project. Harberger et. Al (2007) also points out that deciding the timing of the investment will help to ensure that the resources are not idle. Valuation of Resources Valuation of resources is another important factor that needs to taken care of in order to properly assess the cost and benefit analysis of a project. Valuation of resources often requires translating the costs associated with the project into social opportunity costs. Social opportunity cost is the cost which a society may have incurred if the resources spend on the public projects is otherwise used into the private projects. For the purpose of the valuation it is therefore always assumed that the society will price such resources in accordance with the prices that can be fetched in the private market. Appropriate Discount Rate Another important issue that needs to be dealt with is the assessment of appropriate discount rate. Since while evaluating the different alternatives, it is always desirable that the choice is to be made between the alternative time streams of benefits and alternative time streams of costs it is therefore important that a single value is assigned to each time stream. This single value is often termed as the discount rate which helps assess the viability of the project by assessing its overall riskiness and its ability to distinguish between the proposed costs and benefits of a project. (Feldstein, 1964). Net Present Value and IRR The final evaluation of a project however, will depend upon whether the proposed project will be producing positive net present value or not. Like analyzing the investment projects in private sector, it is always important that public sector projects must return positive NPV or IRR as general criteria for acceptance of the project. It is important to note that a concept of social net present value is often used while assessing the public sector projects. Social NPV takes into account the marginal social benefits and marginal social costs and discount them back according to an appropriate discount rate. (Hirschey, 2009). Hirschey (2009) also points out that the appropriate discount rate for the public sector projects often taken into consideration the economic costs of taxation as well as the uncertainty that may surround the project’s ability to provide intended benefits. Assessing Discount Factor The appropriate choice of discount rate shall always be dependent upon the relative risk and uncertainty related with the project. If the social benefits that are going to be accrued from the project are more risky and volatile in nature, it may be possible that a higher discount rate is applied. On the other hand, however, if the social benefits or time streams of future social benefits are less uncertain, the discount rate can be low. It is important to understand that projects with higher discount rates may not yield the required returns early and as such projects with higher required rate of returns may be discarded provided their NPV is low or negative. The assessment of the real market interest is also a necessary criterion because it is always assumed that the funds have been potentially diverted from the private resources. Thus to assess the correct discount factor it is always critical that the market forces are also taken into consideration while choosing the right discount rate. Further, social opportunity cost is another important element which needs to be considered while choosing the appropriate discount rate for the project. Social opportunity cost, as discussed above, always take into consideration the trade off between the utilization of the resources in private as well as public sector projects. Hirschey (2009) also discusses that the appropriate evaluation of the social opportunity cost and its ratio with social benefits i.e. Social Benefits / Social Opportunity Cost therefore need to be considered for making a choice for an appropriate discount rate. Conclusion There are various criteria for evaluating the cost benefit of public sector project and different underlying methodologies provide alternatives to evaluating the projects. Some of the important factors which need to be considered while performing cost benefit analysis including the assessment of the tax burden on the households and the firms as a result of the proposed project, the overall social benefits which can be accrued from the project as well as the access to technology and information. Cost benefit analysis therefore need to be performed from a diversified perspective while at the same time also considering the comparison between the usage of resources in their best alternative uses and relative costs and benefits of each alternative. References 1. Ballard, C. L., Shoven, J. B., Whalley, J. (1985). . General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States. The American Economic Review. 75 (1), pp.128-138. 2. Boadway,R, Marceau, Mongrain, N (2007). Redistributive Taxation under Ethical Behaviour. The Scandinavian Journal of Economics,. 109 (3), pp.505-529. 3. Boisver, R. N., Mapp, J. H. (1974). A Benefit-Burden Analysis of Public School Financing: The Impact on Rural and Urban Taxpayers. American Journal of Agricultural Economics. 56 (3), pp.578-585. 4. Brooks, N., Hwong, T (2006). The Social Benefits and Economic Costs of Taxation. [online]. [Accessed June 30, 2010]. Available from: . 5. Brown, C, Jackson, P (1990). Public Sector Economics . 4th. ed. New York: Wiley-Blackwell. 6. Divewert, W. (1983). COST-BENEFIT ANALYSIS AND PROJECT EVALUATION. Journal of Public Economics. 22, pp.265-302. 7. Feldstein, M (1978). The Welfare Cost of Capital Income Taxation. The Journal of Political Economy. 86 (2), pp.S29-S51. 8. Feldstein, M. S. (1964). The Social Time Preference Discount Rate in Cost Benefit Analysis. The Economic Journal, . 74 (294), pp.360-379. 9. Hirschey, M (2009). Fundamentals of Managerial Economics. 9th. ed. London: Cengage Learning,. 10. Lee, D. R. (2000). The Hidden Costs of Taxation [online]. [Accessed June 29, 2010]. Available from: . 11. Nicholoson, W (2004). Microeconomic Theory : Basic Applications and Extensions. 9th. ed. New York: South-Western College Pub. 12. Rabushka. A Veldhuis. N (20088). A flat tax for Canada.. Fraser Forum;. 2, pp.6-8. 13. ROBSON, A (2007). No Free Lunch - The Costs of Taxation [online]. [Accessed June 25, 2010]. Available from: . 14. Weiner, N (2010). Adam Smiths Recommendations on Taxation [online]. [Accessed 14th July 2010]. Available from: . Read More