Taxation on Household Savings - Essay Example

of Taxation on Household Savings of Taxation on Household Savings The taxation of household savings comprises of a number of factors, which play a crucial role in the evaluation of a tax system. The first factor is the manner of taxing savings. This is because the taxation on savings plays a vital role in the determination of a tax base. Differences in the tax base occur because the taxation on savings is variable. In support of this statement, comprehensive income tax is a tax base where the income and labor earnings are taxed equally. On the other hand, the expenditure tax is a tax base where the savings from earnings are not taxable until they are used for consumption (Shizuka, 2010). Another factor influencing household savings is the tax treatment of savings. Taxation on savings is an important factor in the determination of the level in, which the tax system notices the differences between the annual income, and the lifetime income. Therefore, the tax system should be designed in such a way that the treatment of taxes on savings will equalize the burden of taxation on individuals. This means that the taxpayers that have differing income patterns and lifetime incomes patterns that are similar will have their tax burdens equalized. The boundary of imposing taxation on a company’s profits and personal incomes creates influences on taxation of household savings. The taxation of income is influential in the determination of self-employed individuals, and small firms. Taxation also influences capital allocation to the large firms. Taxation is also observed to affect the total savings in a particular economy. In this category, the savings mostly affected are those allocated to various assets in a particular country. Taxation on household savings has a significant influence in the amount of capital invested and the efficiency of investment consumption (Dye, 2009). . Taxation on household savings also affects the amount of savings by a particular individual. This is due to reason that the decision to save by an individual is impeded by the tax imposed on household savings. Consequently, individuals result in the assessing the risk of involved in allocating savings to assets. Therefore, taxation on household savings affects the welfare of individuals especially during retirement, and periods of unemployment. During unemployment, and retirement, accumulated savings act as a source of livelihood for the individuals. Hence, it is essential to establish an effective and efficient system of savings taxation (Furman, 2008). People save for a number of reasons. One of which is in order to generate a future income, which acts as a form of financial security. Household savings are generated because of an individual’s sacrifice in terms of consumption, and hence saving can be regarded as a form of investment. A major setback on household savings is the taxation of the normal return to savings. This taxation has the capability of distorting the labor supply, and the timing of consumption. A solution to this problem is the adoption of a neutral taxing system, which eludes such distortions. Consumption tax is a form of taxation that evades distortions in the timings of consumption whereas comprehensive tax fails to evade the distortions on timings of consumption. This is evident from the fact that the consumption tax reduces the after tax rate relative to the pre tax return. Consumption tax also ensures that the rate if return to the consumer determines the price of the current versus the future consumption. Tax neutrality is hence a constructive benchmark, which promotes an understanding of the issues regarding the design of savings taxation. There are various avenues to promoting tax neutrality. One of the ways to promote tax neutrality is through the collection of taxes at different intervals. This is possible through the collection of taxes on household savings up front, and not taxing the returns to savings. Tax neutrality is promoted through avoiding taxation on saved income, and levying takes on the withdrawals from savings. Tax exemption from normal returns to savings is also a way to promote tax neutrality. Tax is only imposed on the excess returns to savings. These measures should be put into consideration during the design of a taxation system on household savings (Furman, 2008). The saving behavior of individuals is highly dependent on the income of the individual. Individuals with low incomes are less inclined to save as opposed to individuals with high incomes. The needs of an individual are also a determinant factor in dictating the saving habit of an individual. For instance, an individual with children tends to save less due to an increase in the household needs. Depletion of savings among individuals occurs as a result of an individual chooses to consume more than the income he or she receives. Therefore, the individual choices that a person makes also determine the amount saved, and the financial stability of an individual. The saving behaviors of individuals are affected by the qualities of a particular individual. This is because different individuals have differing attitudes towards the risks, and the future. This consequently causes the saving behavior of individuals to vary. Therefore, individuals possessing qualities such as patience are observed to save more, and mostly have the capacity to earn more. Imposing taxes on the normal return to savings create saving inefficiencies, and this barely assists in redistribution. On the other hand, the taxation of savings assists the government in generating revenue, which is useful in redistributing. Purpose of a Neutral Tax System The implementation of the tax system that is neutral promotes reforms in the overall tax reforms. These reforms include the setting up of a broader base, which goes hand in hand with the lowering of rates. The broadening of the tax base assists in making the tax code neutral in the sense that it allows limited deductions, and credits for activities that are specified. The tax code is also made neutral through the lowering of taxes. Therefore, these halves working together have the capability to promote effectiveness, and efficiency. Efficiency is determined by gauging the deviation of the tax code from the ideal of pure income tax (Dye, 2009). Neutrality in the tax system also encourages desirable behavior among individuals. This is the case where the tax code is used to encourage credits instead of deductions among individuals. Among the desired activities by policy makers in individuals is the ownership of homes. The tax code is effective in the subsidization of undesirable activities. A good example is in the curbing of spending programs among individuals. It is important to design credits for taxes such that they promote economic efficiency, and largely capitalize on their cost effectiveness (Shizuka, 2010). Neutrality in the tax system promotes healthcare. This is because taxes on medical expenditures are subsidized making healthcare among individuals affordable. The tax treatment on healthcare is such that the purchase of health insurance is favored as opposed to other goods. This treatment of tax in essence reduces the tax on the after price on the health insurance. Neutrality of the tax system also ensures that employees buying health insurance are offered equal advantages as individuals accessing health insurance through employment. Affordable healthcare is accessible through the exclusion of tax benefits, which reduces the tax after cost. This hence encourages people to spend more on healthcare, as opposed to other expenditures. One of the reasons for the promotion of a tax system with neutral opportunities is the fact that it does not change an individual’s choice over when to spend income. This translates into people having more control over their savings, and hence their income. A neutral tax system is also effective because it does not also distort an individual’s choice over the type of assets they are interested in saving. This is a case where neutrality between different types of savings assets is promoted. A neutral tax system is beneficial in the sense that it exempts individuals with savings from heavy taxation. Therefore, neutrality is essential because taxes on the normal returns to savings are exempted. A neutral tax system ensures the individuals that save to consume later in life are exempted from heavy taxation, and are taxed in the same level as the individuals who choose to consume their income early in life. This encourages people to save more, and the government will gain from the taxes imposed on the accumulated savings of the individuals (Furman, 2008). A neutral tax system is one that promotes equity on the taxes levied on an individual’s income, and savings. One way to promote equity on the tax levied on an individual is to tax income at its source. This form of taxation is effective because individual are taxed equally, and hence eluding the heavy taxes imposed on savings. Tax neutrality is also possible through taxing consumed goods otherwise known as taking expenditure. This form of taxation is effective since individuals spend their income in order to sustain themselves. Neutrality between different types of assets is necessary because assets taxed differently result in a case where an imbalance is note depending on the type of investment. One instance is where pensions have fewer taxes imposed compared to other forms of savings. This consequently results in individuals lacking proper future financial plans to save for their retirement. Hence, pension acts a source of income during retirement. Therefore, neutrality between assets is achievable through ensuring that the taxation of future consumption does not affect the supply of labor similar to taxing current consumption. The achievement of neutrality acts as a natural benchmark, which assists in the implementation of reforms (Dye, 2009). The implementation of a tax system with neutral treatment assists significantly in tax smoothing. This is the case where the underlying taxes are considered to be constant. This means that a there is equity in terms of the taxes levied on individuals who save, and those who opt to consume their income earlier in life. Hence, such a system is called a flat tax system where all the tax schedules are moderated. This encourages individuals to increase save more both in terms of assets, and household savings (Furman, 2008). Operating under a tax system with neutral treatment also promotes a constant marginal rate on expenditure. On the other hand, if the expenditure rises at the same rate as the marginal rate, this will translate into the implicit tax levied during instances of low consumption. A tax system that makes consumption in a later date expensive that it is today discourages household savings. This is because the impact of tax on savings tends to remove the condition of neutrality where consumption of savings later is expensive, and hence distorted. Neutrality in the tax system is observed to discourage undesirable activities. This is possible through the role played by pigouvian taxes. Therefore, the tax system has the capability to curb undesirable activities, and habits in the society such as the emission of carbon, smoking, and drinking alcohol. Pigouvian taxes lead consumers account for the social costs of their actions. The heavy taxes imposed on undesirable activities, and behavior assist in limiting the frequency of undesired activities in the society, and hence promoting an overall social efficiency. Proposed Recommendations One of the recommendations is that the revenue collected from taxes should be concentrated on efficient and robust broad based taxes. This means that the personal income of an individual should be assessed comprehensively. income obtained from businesses should be designed to support the economic growth of a nation of interest. The private consumption of resources should also generate revenue. The application of these measures in the tax system assists greatly in reducing the tax burden on individuals. Additional taxes should be allowed where the outcomes result in a recorded increase in the market efficiency. Existing taxes should be abolished, and in the future tax systems. Another recommendation on the tax system is the promotion of progressivity in the transfer, and tax system. The transfer system should be such that it is delivered through transfer payments and personal income tax rates scale. This results in a threshold, which high tax free, and has a constant marginal rate, which offers high simplicity and transparency (Shizuka, 2010). Another recommendation for the tax system is that supplementary systems and income support should be exempt from taxation. A good example is the family assistance. Family assistance should be exempt from taxation because it mostly addresses matters concerning the welfare of children. Assistance from the government in the form of scholarship should also be exempted from taxation. Government payments offer the same assistance as income support and hence exempted from taxation in the same way as the income support. Medicare levy should also be treated as a separate component where it is incorporated into the personal income tax scale. The tax system should also implement reforms that government assistance is utilized and a reduction in the complexity of the tax system. Concessional compensation should also be abolished replaced by outlays or rationalized. Dependency offsets in existence should be replaced, and single dependant tax offsets implemented if the dependant is incapacitated by disability or a case where the dependant has achieved a pensionable age. The zone tax offset should be such that it is based on the contemporary measures (Shizuka, 2010). Employment termination payments, and notational tax offsets should be removed. This is because an individual’s termination from employment lacks a constant source of income hence; imposing taxation would have a significant impact on the financial stability of the individual. Tax systems should also ensure that all forms of salary and wages taxed equally without exemptions. This means that the defense forces and individuals working for government institutions taxed, and the affected personnel directly remunerated. Individuals with foreign employment should not be exempt from taxation. Their income should be taxable at the marginal tax rate. References Furman, J., & Bordoff, J. E. (2008). Path to Prosperity: Hamilton Project Ideas on Income Security, Education, and Taxes. Washington: Brookings Institution Press. Kumhof, M., & Laxton, D. (2009). Fiscal Deficits and Current Account Deficits. Washington: International Monetary Fund. Shizuka, S. (June 06, 2010). The Small Saving Tax Exemption and Japanese Household Asset Allocation Behavior. 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