Effects of Taxation on Macro & Micro economics - Term Paper Example

Term paper on Effects of Taxation on Macro & Micro economics The Overall the study of economic environment is divided into two categories, microeconomics and macroeconomics. The micro-economics deals with individual units while the macro-economic deals national or international economy as a whole. Adam Smith, the famous father of economics was behind the classification of economics. This term paper seeks to evaluate the effect of taxation on both the Macro & Micro economics. Taxation is a key facet in any economy as suggested by Adam Smith in his work on Canons of Taxation .The paper also suggests the areas of further study, in which researchers and other scholars are invited to work on. The Overall the study of economic environment is divided into two halves, microeconomics and macroeconomics. The "Micro" originated from a Greek word. The word means small. Microeconomics entails the study of individual economic units. It is concern with particular individual elements in the economy. It thus gives a worm’s eye view of the economy."Macro" originated from Greek word whose meaning is large. Macroeconomics entails the study of global perspective of the economy. It combines the national or international economy concepts of economy e.g. Total Output, Income and Expenditure, Unemployment, Inflation Interest Rates and Balance of International Trade, etc and what economic policies a government can pursue to influence the conditions of the national economy. It thus gives a bird's eye-view of the economy (Gupta 409) This term paper will focus on taxation as a factor that affects both micro and macro-economic fields. The overall function of taxation is to provide funds to finance the activities of government and can be discussed in the following terms: First, Tax revenue is required to pay for goods and services which government provides: These could be public such as defence or merit goods such as education and medical services respectively. Second, a major function of taxation is to bring about some redistribution of income of income – progressive tax system. Third, Tax revenue may be used to pay interest on national debt. Fourth, Taxation may be used as a fiscal policy instrument to influence full employment levels. Fifth, Social welfare function: is the use of tax to discourage the production of harmful commodities. Sixth,-Protection policy Function. The Seventh function is the economic stability goal by discouraging unnecessary expenditure (Marshall 87). Adam Smith was the first economist to study the principles of taxation and how they affect the economic environment. Adam Smith came up with principles of taxation; these are equity, certainty, economy and convenience. He came to believe that when a tax is imposed certain conditions must be fulfilled. These conditions are what he called canons of taxation (Marshall 324).These are: The Canon of Equity: This refers to the fairness of a tax system. It’s borne out of the feeling that “the states’ subjects should support the government in a proportionate way in regard to the revenue they derive’’ (Marshall 324). This means that every person should pay the tax based on the ability; they don t pay the amount. There are three approaches of achieving equity, namely: The Benefit Principle; under this approach, benefits derived from the consumption of goods and services are used as the basis for taxation. Thus people should be taxed according to the benefits they derive from the consumption of public goods. The disadvantage here is to determine the benefits and expenditure of each tax payer. First, The ability to pay: Here the argument is that citizens of a given country are differently endowed in wealth and earnings. Besides the government cannot raise enough funds to finance public expenditure if each and everyone was asked to pay the same amount of tax. So ability to pay should be the basis for taxation because the tax burden is distributed equitably. However, ability to pay is very difficult to effect because of the difficulty of measuring the ability itself. Second, Equal sacrifice: Here the state should take into consideration the sacrifice entailed by the taxpayer. This is achieved by introducing principle of progression in the tax system. The Canon of Certainty; according to Smith, there should be certainty in taxation because uncertainty breed corruption. .Certainty means that the state should be certain about the amount of Tax Revenue and the time when it’s expected to flow into the exchequer (Marshall 324). The other canon is the, Canon of Convenience; here both the time and the manner of payment should be convenient to the contributor. The other canon is the Canon of Economy; every tax should be economical for the state to collect. If the cost of collection in the form of salaries of tax officials is more than what the tax brings as revenue, such a tax is uneconomical. Secondly, it should be economical to the taxpayer, i.e. He should have sufficient money left with him after paying the tax, a very heavy tax, on income will discourage saving and investment and thus adversely affect the productive capacity of the community (Marshall 324). Taxes are categorised on the following basis: First, the impact of tax and the incidence of tax. The Impact of the taxes; it means on whom the tax is imposed (Shirley et al 30).The tax incidence refers to the bearers of the burden due to tax. The tax incidence classifies tax as Direct and Indirect. A direct tax is one where the impact and incidence of the Tax is on the same person e.g. Income Tax, death or estate duty, corporation taxes and capital gains taxes. It can also be defined as the tax paid by the person on whom it is legally imposed. Indirect Taxes; these are imposed on an individual mostly producers or traders but they can be passed on to be borne by others usually the final consumers. They can also be defined as taxes where the incidence is not on the person on whom it’s legally imposed. They include excise duties, sales tax, Value Added Tax and others. The Second category of tax rate is on the basis of the rate of tax. The tax rate refers to the tax percentage charged. Here tax rate cab is either: progressive rate, proportional rate, regressive rate and digestive rate. A progressive income tax system is one where the higher the income, the greater the proportion paid in taxes. This is imposed by dividing the taxpayers’ incomes into bands (brackets) upon which different rates of tax are paid – the rates being higher and the band of income. The Proportional Tax is where whatever the size of income, the same rate or same percentage is charged. Examples are commodity taxes like customs, excise duties and sales tax. Regressive Tax is tax type whereby the poor bears a greater burden than what is borne by the rich. No civilized government imposes a tax like this. Digressive Tax entails a less burden on the higher incomes than other incomes (Shirley et al 31) The Economic Effects of Taxation include: First, restraint on work; when tax burdens are heavy there is a high like hood negative on production. Heavy taxes may encourage absenteeism leading to decline in production activity. The taxpayers are not motivated to work in a system of heavy taxation. The incentive to work can be increased through indirect tax (Marshall 325). Secondly, Tax discourages saving; Taxation usually leaves taxpayer with less on no surplus at all as much of their money is challenged to the tax systems. This result to no savings because the taxes are discourages by the taxpayers on having savings on their income. The third effect is a decline in enterprise activities; entrepreneurs venture on risky activities only if they are assured of greater returns on their undertakings. Heavy taxes reduce the revenue from the ventures hence discouraging more investments activities. They don’t get a good deal on the compensation on the investments costs. The entrepreneurs are not motivated to do more investments hence leading to decline in the growth rate of the economy. Heavy taxation does not give the entrepreneurs the justification of their investments. Fourth, Taxation may lead to higher inflation levels. In a full employment economy increases in indirect taxes results to higher wages demand. This in turn results to higher supply of money to meet the demand, hence leading to inflation. Taxes on purchases lead to higher retail price. This results to even higher demands for wages to meet the rising cost of the products. Fifth, Diversion of economic resources; Economic resources are not evenly distributed in an economy with heavy burden of taxes. Taxation affects the elasticity of demand and supply of resources .For instance heavy taxation on a certain commodity which is a raw material may shift the demand of the commodity due to the increases on the cost of production. The production of such a commodity may be hindered hence affecting the supply of the commodity due to the tax forces. Additionally, heavy taxes on certain business ventures may force entrepreneurs to channels the savings on more favourable ventures (Vanitay et al 37). In conclusion taxation is a key facet in every economy. Taxation impacts on an economy either positively or negatively. Therefore governments should come up with effective tax framework that would enhance the growth of the economy. This term paper welcomes researchers and other scholars interested to carry out on Effective taxation framework required for an optimal economic growth. Works Cited Biographiq. Adam Smith; Life and Times of a Political Economist. Minnesota: Filiquarian Publishing, 2008. Marshall, Alfred. Principles of Economics. Oxford: Osprey Publishing, 2007. Otteson, James R. Adam Smith. London: Continuum International Publishing Group, 2011. Shirley Dennis-Escoffier, Karen A. Fortin. Taxation for Decision Makers. Stamford: Cengage Learning, 2007. Vanitay, Agarwal. Macroeconomics: Theory and Policy. Delhi: Pearson Education, 2005. Read More