Excessive Rates of Income Tax Destroy Enterprise - Essay Example

Taxation By Due Excessive rates of income tax destroy enterprise, encourage avoidance and drive talent to more hospitable shores overseas. As a result, far from raising additional revenue they actually raise less. Taxes have a great influence on consumer behavior. The objectives of taxation are to raise revenue for Government expenditure and boost the economic development of the country. The taxation authorities look into the methods of taxation every now and then so that sufficient revenue is raised without imposing unreasonable burden on the taxpayers.

However, sometimes, the Government is forced to make radical changes in taxation and there seems to be a trade-off between the objectives of taxation. Especially, a problem can occur when rates of taxation are increased. Progressive taxation is a tool that taxes lower income groups less and higher income groups more. In this system, the marginal rate of tax is different from the average rate of tax. When marginal rate of tax is increased, the substitution effect comes into play. The substitution, here, relates to substitution between work and leisure.

Normally, the taxpayers are expected to work more when the rates of taxes are increased. However, in UK, an industrialized country, it has been observed that higher marginal rates give a disincentive to work because the workers start to obtain less benefit from every extra hour that they work. Therefore, they prefer to use those hours as their leisure time and it gives them more pleasure. The given statement highlights the disadvantages of the progressive tax system and strongly opposes it. Progressive tax violates the principle of equity under the law because every income group is taxed differently.

It causes resentment on the part of higher income groups as they are taxed at a higher rate. A powerful and adverse effect of progressive taxation is on savings. High rates of tax cause the higher income groups to save less than before. If they save less, lesser money would be available for the investment sector. It is because, generally, the higher income groups can easily pay for the necessities and their excessive income is used for capital goods. Progressive taxation, therefore, leaves less revenue for capital goods i.e. investment.

This is detrimental to the country’s progress and economy. When we talk about taxation, one of the major problems is that of evasion. Progressive taxation tends to enhance this problem because when high income means more tax, the people with high income would look for ways to show that their income is lesser than it actually is. Progressive tax encourages this behavior and precious revenue is lost. This is unlawful and harmful to the economy. Also, increase in tax avoidance means increase in the workload of accountants and lawyers.

So, the collection of tax becomes costly. Another major problem is of “Brain Drain” which means that precious talent can be lost due to high taxes. When talented entrepreneurs, who earn at higher level of income, are taxed at higher rates, they look for places where their income would be taxed at a lower rate. In search of “tax havens”, they move to other countries and precious talent is lost. The emigration of such talent is directly proportional to the rates of tax. The higher is the rate of tax, the more talent relocates.

It is more enhanced by the fact that taxes are not internationally harmonized and there are different rules in different countries. UK might lose most of its talent to the US as a result. Other problems related to progressive taxation are increases in tax loopholes. For instance, the technique of income splitting increases. Businesses with high level of income split their businesses into smaller groups so that their income falls into a lower tax bracket. Also, progressive tax system can prove to be a very complex system.

Not only for the taxpayers, but also for the tax collecting authorities, it can cause some serious problems in its implementation as a fair tax system. It has been commonly argued that those people must pay more tax who obtain the most benefit from it. In the case of progressive taxation, it cannot be suggested that the higher income groups obtain the most benefit from this taxation. All of the problems discussed above culminate in the collection of lesser than projected tax revenue. Therefore, progressive taxation is tantamount to inefficiency.

Progressive taxation has also been opposed politically at times. It is demanded mostly by the lower income groups which want a limit on high earning of income. In the US, the implementation of progressive taxation was regarded as “politics of envy”. This sheds some more light on the fact that progressive taxation is a system based on inequality. It prevents the people who fall in higher income groups from working hard and earning more. This system retards the economy and there is no boost in innovation and economic development.

The statement by Nigel Lawson is absolutely true. In order to evade these problems, such a tax system should be devised that does not put unreasonable burdens on the taxpayers. The tax system must be fair, simple and justifiable. Taxation is a tool that is used to increase the economic development of the country. A tax system that retards the economic development is a failure on all grounds. References James, Simon and Christopher Nobes. The Economics of Taxation. Financial Times/ Prentice Hall, 1999. Print.