A Neutral Tax System - Essay Example

A NEUTRAL TAX SYSTEM + Submitted A Neutral Tax System Empirical analyses of literature on economic surveys reveal that taxation has played one of the most notable roles in improving the economy of UK. Savings and taxation play a central role in evaluation of economic development of any country. Further, taxation and saving influence the decisions of people involving spending and in consideration of the risks associated with spending and failure to save (Nightiangle 2004, 20). Tax system informs the taxpayers on stability of their future after retirement and their economic positions in the event that they become jobless through retrenchment or economic recessions. This paper details the study of taxation in relation to savings. Taxation entails the means that the government uses to finance its expenditure by imposing charges on corporate entities and individuals. Taxation is one of the most fundamental organs in any economic system. For taxpayers, there arise varying purposes and needs to provide tax systems that ensure neutrality of treatment. A neutral and non-burdening tax system provides taxpayers with the ease and enthusiasm to understand the general objectives of the taxes that the government collects from them and to gain interest in the calculation of the relevant income taxes. Taxpayers are able to understand and clearly calculate the national insurance and capital gain taxes. Neutrality of a tax system determines people’s choices on when to spend the incomes they receive. Household saving enables individuals to save whenever the amount of money they prefer to consume varies from the incomes they receive. For example, individuals find it hard to spend whenever their incomes are less than their desired budgets. Therefore, the decision made by such individuals in their spending relies more on their immediate desire to gratify their needs than on the long-term thinking for their future (Porteba 1994, 229). The current tax system of the United Kingdom has encouraged the syndrome of little saving for households with little income. People save meager amounts of their income especially when they have more needs than their proceeds can afford. Given poor rationality, there is a force driving the government to accumulate pensions, savings and social insurance. The government’s move to accumulate these ensures that the current taxation system directly affects the welfare of people. The impact is felt most on retirement and for the unemployed. Occurrences of unemployment and retirement have immense impact on the welfare of citizens. It is imperative to have a tax system that embraces concepts of neutrality to cushion the whole nation from the sufferings of retirement and unemployment. Present scheme of taxation in the United Kingdom acts as a technique and a tool through which the government discourages or encourages some financial decisions within the country. For instance, the government may decide to impose extreme taxes on goods that have negative externalities on the lives of the citizens. This discourages prospective investors from investing in the fields with high taxes. Furthermore, the tax system that the country has in place has a crucial role to play in determining the extents to which systems appreciate inter-personal dissimilarities in lifetime income (Cordes 2005, 29). Therefore, the process of taxation shapes the conducts of small and medium enterprises and influences the allocation of economic resources by large firms. Given this, careful design of savings and taxation techniques leads to equalization of tax burdens for taxpayers with similar lifetime incomes. Description of the Proposed Recommendations There are different systems of taxation paying and specific ways UK can use for reform. To begin with is the analysis of people real saving behavior. This helps one in understanding the benefit of taxation. The first case of study is excluding the normal returns on taxation to saving. This includes among other factors the reasons that people save in the first place. People save in order to consume their benefit from period to another. People sacrifice consumption in order to generate future income by saving and make an exemption of future returns. Taxing normal returns distorts timing of the lifetime consumption and labor supply. A timing-neutral tax system does not create distortions and several tax systems gets this neutrality. A consumption tax does not lead to any distortion in the period of consumption but a comprehensive income tax leads to distortion. This is because it reduces the tax rate of the returns since the rate of the returns the consumer gets determining the effective price of future and the current consumption. The main aim is to avoid the distorting intertemporal choices for almost half the population in three possible ways of saving taxation and maintaining neutrality during consumption. This is explained in terms of the inherent difficulties in a long income tax and additional distortion like returns to saving that are taken as capital gain or income likely introduced by tax. In the research on saving and taxation, economical theory inadequately provides unequivocal recommendation on matters regarding optimal tax design. Tax neutrality is used for analysis that is a constructive benchmark for understanding issues related to design of saving taxation. Individuals differ in their saving behavior in regards to their opportunities and preferences. Different ways to neutral taxation entail gathering taxes at different periods. One route involves collecting taxes from up front and not5 from the returns of savings. Another way involves not levying taxes on income saved but taxing withdrawals. UK taxes pensions today. The last route is excluding normal returns on savings and taxing the excess or supernormal returns. The differ4ent in these systems is the different rates of their taxation at diffident times of each individual. The system has different effect ct on the individual incentives saving according to their ways of consumption and income. People are required to select their own system of saving to create a smooth pattern of taxation of income between different times. In selecting taxation of saving, one needs to consider the taxation on borrowing and on the human capital. In future, change in investment and financial investments will cause a distortion between the two margins. An economic case of taxing normal returns will lead to ambiguity as suggested by several analysts leading to unclear conclusions. Neutrality is the main benchmark for presuming assumptions on neutral system. From an overview of the concept of taxation and savings of households, a number of recommendations arise for the improvement of the current tax system. Foremost, the taxation system needs to exist as a whole. This implies that an effective system would meet the overall expenditure needs. Further, not all taxes imposed by a taxation system need to target all goals. Therefore, increasing the desired intensity of progressivity in the UK tax system would require adjustment of direct personal taxes and benefits. Secondly, there is need to seek neutrality in the tax system. Simplicity of a tax scheme relies on the analysis of similar economic activities in the same way. This coherence of methods of analysis helps avoid situations of discrimination between people and different economic activities involved. A revision of the tax system in accordance with the review poses a number of scenarios for winning and losing. Insurance companies stand as one of the biggest winners of the proposed changes to the tax scheme. A change of the system would see more business for insurance companies (Mkwezalamba 1995, 71). More business means more proceeds and thus a good financial base for investments. Further, more investment resulting from increased revenues means more employment opportunities for the citizens. Further, there will be a reduction in the dependent feature in taxation by the government when individual contributions finally face division from likelihood of needs. Taxpayers are the other benefactors of the proposals. Transforming the collected taxes into essential amenities such as healthcare and education would provide taxpayers with a number of benefits. The general taxpayers will be able to access improved healthcare services across government hospitals and clinics. Better-equipped public learning institutions would ensure that all children receive quality education irrespective of their parents’ income status. The benefits will accrue to everyone; even those who may not be contributors of the household tax. Furthermore, the rich and high-income earners are the other winners in the proposed system. They are still able to save even in the steep rates of taxation and in turn pass the costs to their employees and juniors. Other than those that are most definitely going to benefit from the changes, some groups will be negatively affected by the new tax system. Foremost, low-income earners and the poor citizens will suffer the most. Taxation of the savings of the poor people discourages their ambitions to save. Small and medium enterprises also stand a chance of losing in the system. Heavy taxation of these firms affects their output. This could lead to fallout or collapse of the firms (Ault 2010, 39). Taxing their savings leads to reduced funds and resources to expand their investments. The proposal has some notable strengths as well as weaknesses as it relates to economic growth and prospects of development. Taxation is crucial in realization of economic development of any country. One of the strengths of taxation of household savings is that it allows evaluation of an equitable way of assessing tax (Ault 2010, 119). This is due to the fact that people do not consume at the same rate. Additionally, savings are easier way to pose tax and decide deductions in relation to a person’s proceeds. This results when populace make a decision to consume thus saving every receipt for every purchase. Since taxation is mandatory, the system tries to place the frequency of occurrences of problems that are common to voluntary insurance markets minimal (Salanié 2011, 333). Therefore, the strengths come from integrative and the political nature of distributing and rising tax revenues within the state. The tax revenues that the nation will receive from household savings taxation will be used for funding universal health coverage. This has the benefits of pooling risks across a vast entity of persons. It provides great benefit to the population when they pay for their medical expenses through their savings and incomes. The system also allows for easy evaluation and carrying out taxation processes. Taxation of household savings poses notable benefits in influencing the amounts of savings in the economy as well as influencing the allocation of savings amongst various assets. One major weakness of the proposal is that it may distort decisions in favor of financial savings based on an individual’s capita investment. Furthermore, it may lead to a situation where current leisure does not harmonize with the future expenses (Kaplow 2011, 39). Taxing an individual’s savings affects the person’s future investments because of the taxes withdrawn from the savings. The taxes that the government will draw from the savings may discourage people from saving with various institutions. Reduction in savings may lead to reduced investment by various firms. Reduced investment resulting from taxation of savings leads to reduced resources in the economy. This negatively affects the economy at large. In conclusion, taxation involves remembering the cost of tax management, tax distortion in the economy and the political relations. For example, the net equity of healthcare system funding depends on the amount of funds that a tax system mobilizes (Cordes 2005 pg121). Additionally, it entails the way of spending cash relating to progressivity of the taxes. Furthermore, even the most triumphant tax system faces customary criticism. Thus, for flourishing taxation, there should be; change in allotment of formulas, decentralizing responsibilities, disentanglement of purchasing from provision, experimenting with new payments machineries and branding only the most significant ones (Poterba 1994 pg 117). List of References SALANIÉ, B. (2011). The economics of taxation. Cambridge, MA, MIT Press. POTERBA, J. M. (1994). Public policies and household saving. Chicago, University of Chicago Press. CORDES, J. J. (2005). The encyclopedia of taxation & tax policy. Washington, D.C., Urban Institute Press. MKWEZALAMBA, M. M. E. (1995). Interest income taxation and household saving behavior in less developed economies: an empirical investigation. Thesis (Ph. D.)--University of Illinois at Urbana-Champaign, 1995. NIGHTINGALE, K. (2004). Taxation: theory and practice. Harlow, England, Financial Times Prentice Hall. AULT, H. J., & ARNOLD, B. J. (2010). Comparative income taxation a structural analysis. S.l, Kluwer Law International. KAPLOW, L. (2011). The Theory of Taxation and Public Economics. Princeton, Princeton University Press. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=769614. Read More