Impact of Cutting Corporate and Individual Tax to Firms and Individuals - Essay Example

Impact of Cutting Corporate and Individual Tax to Firms and Individuals Introduction Direct tax constitutes the significant proportion of individual and organizations’ cost. It serves as one of the major sources of revenue to the governments. By definition, direct taxation refers to remittance of tax to the tax authority, by an individual (natural or juristic) upon whom the tax burden is imposed, and it includes corporate tax and personal income tax. Taxation impact on investment and growth has been hotly debated in both political and academic arena. There is are two divides on effect of cutting direct tax in the social circle, one divide supporting tax cut and the other one opposing it. The proponents of direct tax cut point out to the effect that low direct tax has on incentive to save, to invest and to work. They argue that lowering direct taxation has a positive impact on economic growth and development (Giavazzi and Pagano 2006, p. 20).  On the other hand, the opponents of direct tax cut argue that a low tax reduces government’s earnings which inhibit the government from initiating expansionary fiscal policy. Expansionary fiscal policy leads to economic growth which facilitates investment, organizational developments and individual entrepreneurship. Despite the impact on the wide economy, direct tax affects the disposable real income that both organization and individual have. Real income is used for investment, expansion, entrepreneurship and other uses by the organization and individuals (Nickell and Bell 2007, p. 296). As such, any move to raise or cut direct tax will have both long term and short term critical impact on the economy, individual and organization. The ensuing segment analysis the benefits and costs of cutting direct tax to both firms and individuals. Possible benefits of Direct Tax Cut to Firms and Individuals Direct taxation affects the organizational growth and development through its impact on total factor productivity and factor accumulation. Direct taxes reduce the income that organization and individuals get. Reduction in the income means higher operational costs. This induces efficiency loss in the allocation of resources and distorts factor prices (Ferede and Dahlby 2012, p. 565). Organizations pass down their cost to the consumers. When the government imposes high corporate on the organization, organization respond by raising the price of their products and services. High prices discourage consumers from taking most goods, for example, when there is a general increase in price of all commodities; consumers reduce intake of luxurious commodities such as vehicles and jewelleries. Reduction in the consumption of some goods affects the organizations that produce them negatively. Cutting direct tax will reverse the impact of high taxation into the organizations. If the government reduces the rate of direct taxation, the organization costs will be low. Organizations sell their services and products at a lower price when they have lower operating and production cost. Lower prices increases real incomes to the consumers which make them want to consume more. Higher consumption of goods and services fosters economic growth and organizations profitability. Therefore, cutting direct corporate tax increases organization financial performance. Higher performance enables the organization to produce more goods or services, offer quality goods and expand operations. A profitable organization has a competitive employee’s package, thus attracting the best talents in the market. Having competent human resource team is very crucial in determining the quality of services that the organization renders or the quality of products that it produces (Goulder 2005, p. 275). Firms’ retained earnings are used for investment. Retained earnings are obtained from the revenue of the firm. Taxes reduce incentive to invest and raise the cost of capital. Direct corporate tax provides sectors preferential which distorts the allocation of capital and reduces the overall investments productivity. Organizations invest from their real income. Direct taxation reduces the amount of funds available for investment. This reduces the capability of the organization to expand, grow and develop. As such, reduction in the direct taxation to the firms leaves them with more disposable income which will facilitate them to invest. Like organizations, individual’s personal income tax reduces their real income. When individual work more for the government than for themselves they lower their productivity level which lowers the economic performance, for example, between the 1960 and 1980 the rate of direct taxation in the United States averaged at 50%. During the same period, the inflation rate increased reaching 13.3% in the year 1979. In the same period, the tax burden was 20.8% of GDP. This crippled the performance of the economy and reduced production in the country. After the introduction of ‘Economic Recovery Tax Act of 1981’ which reduced corporate and personal tax, there was heavy investment in the country that was characterized by high productivity. The move also contributed to higher revenue to the government from five hundred billion in the year 1980 to one trillion dollars in 1990 (US Department of the Treasury 2003, p. 32). Lower direct taxation gives individuals and organizations an incentive to invest. The incentive rises because investors can get more value for their investment. When investors get incentive to invest, they invest more in the economy which is not only beneficial to them, but also to the government. Government uses tax as the main source of its revenue, when there is more investment in the economy the government gets more revenue, and it expands the economy which creates more room for developments. High investments reduce an unemployment rate (Lang et al 2013, p. 83). Low unemployment rate leads to the low rate of insecurity and crime. This facilitates entrepreneurship and organization growth. Therefore, cutting direct taxation increases organizations productivity, entrepreneurship, investment and economic development. Possible Costs of Direct Tax Cuts to Firms and Individuals The theory of real business cycle proposes that cutting direct tax will have no impact to either organization or the individual. In the model, when the government reduces direct tax, organizations, and individuals anticipate that the government will increase the direct tax rate in the future. This makes them reduce spending. The benefit of tax to an individual, organization or government is when extra amount is used for investment. Therefore, cutting direct cost will make individuals spend less which will lower the productivity of the firms. When people anticipate high cost of living in the future, they start to save and reduce consumption (Lang et al 2013, p. 88). Lower consumption reduces the velocity of money in the economy which hinders performance of the private sector. Higher income households pay more tax when the progressive taxation system is used. Lowering the personal income tax shields the rich in the society from remitting more tax. For example, in the year 2001 and 2003, President George Bush signed into law direct tax reduction laws. This move gives high-income households more tax benefits. This widens the gap between the rich in the society and the poor. When personal income tax is reduced, the middle and the lower income do not benefit much. As such, cutting personal and corporate tax can bring about rift in the society. A divided society is less productive. Cutting corporate tax creates more job opportunities due to high investment in the economy. High rate of employment leads to a high cost of labour. Labour is the most expensive cost to the organization. When the cost of labour rises, some organizations relocated their business to other regions, where the cost is low or increases the cost of their services and products. This leads to poor performance of the economy which in turn reduces the organization performance, reduction in investment and low rate of productivity. Low direct tax increases the cost of labour to organizations, and on individual capacity, they inhibit entrepreneurship (Nickell and Bell 2007, p. 296). Taxation is used as a way in which governments earn income. When government has high income, it spurs development. Government facilitates environment in which private sector can operate. This is achieved through both monetary and fiscal policy, for example, when the economy is at recession, the government initiatives expansionary fiscal policy. This policy would include such initiatives as building the infrastructure and providing more social benefits. In undertaking these initiatives, the government will offer create more job opportunity and increase the amount of money that is circulation in the economy. When there is high circulation of money, people spend more which leads to high performance to the organizations. When government cut direct tax, it reduces the disposable income that it has. This means that it will not undertake initiatives that will facilitate growth of investment, entrepreneurship and economic performance. The organizations and individuals will, therefore, be discouraged from investing more in the economy (Ferede & Dahlby 2012, p.580). Discussion Cutting direct taxation on personal and corporate income has both negative and positive impact to individuals and firms. Direct result of cutting personal and corporate tax is an increase in the disposable income to these parties. It has an indirect influence through, influencing government revenue that affects the extent to which government can have input in the market factors. A critical analysis of benefits and costs of cutting personal and corporate tax, it is evident that this move will lead to more benefit to the organization and the individual than the costs that it causes. Those that argue against cost cutting cite inequality that cutting direct tax will bring to the society and business operations. This argument can be well explained by using the Lorenz curve. This curve represents the inequality in wealth distribution. The curve shows that the minority group owns most wealth in the country For example; the curve indicates that bottom 20% of the households in the country owns 10% of the total income. On the other, hand, the top 10% of all households owns 20% of the country’s population total income (Nickell and Bell 2007, p. 296). When the government cuts personal tax, it will be benefiting the minority in the community. The high-income individuals remit more tax and cutting the taxation rate will make them have more benefits which cause dissatisfaction in the society and the gap between the poor and the rich. However, reducing taxation encourages the high-income individuals in the society to invest more. High investment creates more job opportunities which increase the cost in the labour market. When the price of labour rises, the low-income people earns more which bridges the gap between the high income and the low-income earners in the society (Agrawal 2006, p.56). Cutting corporate tax is criticised for raising the cost of labour and reducing government facilitation of an ambient business environment. However, the cost of labour is increased by the growth in the economy which enlarges the market for products and services. Firms perform well financially and have more profits in an enlarged market. Therefore, they are able to pay the increased labour cost and retain more funds for investment. Cutting corporate tax increases the earning of the government in the end. Therefore, the government gets enough funds to facilitate private sector development, entrepreneurship and organizational growth. Corporate and personal taxes lower the amount of investment and entrepreneurship in the country. When an individual has more disposable income, it gives them access to capital that can used to fund their enterprise, for example, when the income of an individual increases, the financial institutions increases the amount of loan that he can access. This boosts the entrepreneurship (Giavazzi and Pagano 2006, p. 23). Conclusion Reducing operating costs and other costs is very significant undertaking for firms’ growth and expansion. Personal income is used for individuals spending, saving and investing. High income increases savings and investments proportion of the individual income. This is because most of the basic needs consumption does not increase with an increase in the amount of disposable income. Cutting direct tax has more positive effect to organizations, individuals and economy than the negative effects. In conclusion, firms and individuals will have more benefits than costs through personal income tax and corporate tax cut. References List Agrawal, K. (2006). Direct tax planning and management. New Delhi, Atlantic Publishers & Distributors. p. 56 Ferede, E. & Dahlby, B. (2012). The Impact Of Tax Cuts On Economic Growth: Evidence From The Canadian Provinces, National Tax Journal, September 65 (3), pp.563–594 Giavazzi, F., & Pagano, M. (2006). Non-Keynesian effects of fiscal policy changes: international evidence and the Swedish experience (No. w5332). London, National Bureau of Economic Research. p. 16-39 Goulder, L. H. (2005). Effects of carbon taxes in an economy with prior tax distortions: an intertemporal general equilibrium analysis, Journal of Environmental economics and Management 29(3), pp. 271-297. Lang, M., Pistone, P., Schuch, J. & Staringer, C. (2013). Introduction to European tax law : direct taxation. London, United Kingdom, Spiramus Press. pp. 82-84 Nickell, S. J., & Bell, B. (2007). Would cutting payroll taxes on the unskilled have a significant impact on unemployment? London, Sage Publications. P.296 US Department of the Treasury (2003). History of the US Tax System [Online]. Accessed 8th April 2014. Available at: http://www.policyalmanac.org/economic/archive/tax_history Read More