Does the General Sales Tax Affect the Personal Consumption Expenditure - Research Paper Example

Does the General Sales Tax Affect the Personal Consumption Expenditure? Taxes forma source of revenue to the state. This revenue is used to stir economic growth and development of the country. Taxes are imposed on goods; fines are levied on businesses by the local authorities and all employees pay taxes on a scheme commonly known as Pay as You Earn. Failure to pay such taxes attracts a penalty that is paid in the form of a fine. Sales tax is the commonly known tax and it is imposed on goods mostly sold by the retailer to the consumer. This paper seeks to study the relationship between sales tax and individual consumer expenditure and saving. Table of Contents Table of Contents 2 1.0. Introduction 1Sales tax is part of consumption tax, tax on imposed on spending on goods or services in various states. Sales tax is usually imposed to buyers during the purchasing of goods or services. The sellers are the one who collect the tax. Tax rates vary from one state to another. In United States, the sales tax has been increasing drastically since 1997 and this has led to rise of prices of both services and commodities. The people who are affected indirectly by sales tax are the buyers. Their expenses rise per month forcing them to draw narrow budgets. This is the same in the whole world and the economies of many nations are going down. What it exported or imported is also highly taxed. Sales tax is different from value added tax because it is only imposed once at the retail level. Different states in United States have different tax rates. There are some jurisdictions in these states that determine the tax rates to be imposed on various goods and services. Goods for manufacture or resale are usually exempted from sales tax. Some other jurisdictions also exempt sales tax on foods sold in grocery shops, agricultural supplies and prescription medications. Sales tax greatly affects the spending of consumers, changes their consumption behavior and marketplace at the household level. 2.0. Literature Review There are many researches that have been done to show how the increase in sales tax affects personal consumption expenditure. Most of the results got from these researches have showed negative impacts on personal consumption expenditure. As Kevin 2001 puts it, this has been the case in the 2United States of America and the rest of the world. In a case study conducted in California in 2007, it was revealed that the best sales tax rate was 7.25%. This was a rapid increase from 6.6% in 2004 while in 1990s it was less than five percent. Most of this was taxed because of transport expenditures that were incurred during transportation of the goods or services. The estimation for the next year after 2007 was 7.75% tax rate and this was observed to be the trend to be followed unless the economy in the whole world is restructured since the people in California must rely on imported and exported goods and services. In this case study, the main objective shall be to show the effects of increased sales tax on the well-being of people in California. The methods that shall be used shall help to come up with resourceful data that shall be analyzed in depth. From the analysis, it shall be clear on the real effects that are caused by increased sales tax. Increase in tax rate has been there in California just as it is with other states in America. Some of the effects may be positive; however, many of them are negative. To the unemployed the situation is worse thus, there must be proposals to look into the issue deeper before it goes beyond recognition. From another research done in the same state to identify the much that is used for consumption by individual persons, according to Kanbur and Spence, it was found out that 65% of the spending per individual was on consumption. It was not, however, constant as it varied with genders and age. There were many reasons that were given for the high spending in consumption and the main one was increased sales tax. Sales tax was also observed to change consumer behaviors such that they draw narrow and fixed budgets. 3.0. Theoretical Framework 3Economic theories are broadly classified into two categories: macroeconomics and microeconomics. Microeconomics is associated with economy at a smaller level or scale while macroeconomics is associated with the study of the overall economy behavior. Economics can be defined as a social science discipline dealing with the allocation of limited resources in an endeavor to satisfy human wants, which mostly are unlimited. Macroeconomic theory is generally referred to as a set of principles describing how key macroeconomic variables are determined. These key macroeconomic variables are output, employment, inflation and interest rates. There are a number of macroeconomic theories and they include monetarism, Keynesian economics, supply-side economics, and the new classical economics. Every theory has its own policy recommendations and every proponent hopes that governments will follow them. For this research, classical economic theory commonly known as the classical macroeconomics is used. This theory dominated the capitalist economies before the advent of Keynesian economics way back in 1936. The proponents of this theory, classical economists, believed in free markets and the belief that through forces of demand and supply, the economy would always achieve full employment. So, if the numbers of job opportunities is less than people seeking the opportunities, wage rates will tend to fall until all those seeking for employment are absorbed. In this case, markets forces determined full employment of workers. 4Full employment level will result into a fixed aggregate output income and price level was determined by the supply of money in the economy. In this case, in a fixed output level, a ten percent increase in money supply translates to a price level increase by ten percent. In addition, determined by forces of demand and supply in the market is the real interest rate defined as the difference between nominal interest rate and the inflation rate. Therefore, classical economists believed that in order for those market mechanisms to work, market structure had to be that of perfect competition and those prices and wages had to be fully flexible. Proponents of classical macroeconomics believed that since full employment equilibrium in the economy was driven by market forces, government intervention was not significant. The purpose of this research is to determine if general sales tax affects the personal consumption expenditure. A sales tax is a tax imposed on certain goods and services and is paid by the consumer during purchase and is charged separately from base price. Sales tax dates back to 2000 BC when tax was imposed on sale of goods by the Egyptians. There are a number of sales tax and include; gross receipts taxes which is levied on all business sales, excise taxes usually imposed on the producer or wholesaler, use tax which is directly imposed to the consumer on goods without sales tax, securities turnover exercise tax imposed on securities and value added taxes imposed on all sales. Personal consumption expenditure is the comprehensive measure of a consumer’s usage on a monthly basis, counting all expenditures on durable goods, consumer products and services. 5This research is important because personal spending has an inverse relationship to personal saving. Studies reveal that general sales taxes reduce consumption expenditure. They are known to result into and saving less as compared to any other form of major-revenue tax. High consumption and production levels can lead to an increase in overall prices. In this study, the independent variables are sales taxes for various goods in a range of five months, an individual monthly consumption or expenditure and what the individual saves in each month. The dependent variable will be the consumers’ salary. 4.0. Methodology and Sources of Data This section deals with the description of methods used in carrying out the research study. A change in sales tax will be examined on how it affects both individual consumer expenditure and personal saving. Results for research will be derived from the comparison between the rate of consumption when the sales tax is at a constant rate, when it is raised and when it is reduced. Consumption here will be calculated as follows; C = L E – S and CU=C/CST Where C is for consumption, CU is for consumption units, LE refers to the labor earnings, and CST refers to the current sales tax in percentage while S refers to the saving. Four labors earning of different individuals are picked, in the study, it is assumed that each individual saves ten percent of the monthly earning. It is also assumed that the individual consumption is what the difference between the total earning and what the individual saves. 6Examples for the study are given when the sales tax is at twenty eight percent, when the sales is raised to thirty percent, when the sales tax is reduced to twenty six percent and when the sales tax is cut off completely. 5.0. Empirical analysis At a constant sales tax of twenty-eight percent, a personal consumption expenditure of an individual earning $400 a month and saves ten percent of his salary will be will be calculated as follows C = L E – S C=400-400/10 C =400-40 C=$360 CU=360/0.28 CU=360/0.28 CU=1285.7Units Table 1. Effects of sales tax change on the consumption units LE in $ C in $ S in $(10%) CST in % CU CST in % CU 100 90 10 28 321.4 26 346.6 400 360 40 28 1285.7 26 1384.7 1000 900 100 28 3214.3 26 3461.5 10000 9000 1000 28 32142.9 26 34615.4 7The table above clearly reveals that a change in sales tax affects the consumption expenditure. When sales tax is high, the consumer units are low. This means that an individual will not be able to make his her whole purchase. In order to balance the equilibrium, the individual will be forced to reduce his, her monthly consumption or use part of the saving to substitute. When sales tax is low, consumption units are high; here an individual will have enough money to meet the monthly contribution. The consumer units are more than he/ she needs and one can spare part of that more for saving or investment. It is evident that a one cent increase in sales tax is comparable to a one percent price increase of the taxable goods and services and vice versa. Table 2.Effects of sales tax cuts on the Personal Saving Rate   Permanent Cut Transitory Cut   Anticipated Not Anticipated Anticipated Not Anticipated Before effective date Saving rate falls No effect Saving rate falls (but less than in permanent case) No effect After effective date Saving rate returns to previous level Minimal or no effect Saving rate rises above previous level Saving rate rises above previous level 8The table above gives a comprehensive summary of the effects of temporary and permanent tax reductions on respective personal saving rates. The effects of tax increases would be the reverse of those shown in the table. A sales tax, to a point that it results into an increase of the prices of goods and services, influencing saving and consumption in the following two ways: Sales tax absorbs the purchasing power that might be available for saving or consumption Sales tax also penalizes consumption spending at the same time offering no immediate discouragement to saving. 6.0. Policy Recommendations and Implications General sales tax comprises different types of levies; retail sales taxes, manufactures exercise, gross sales taxes and value added taxes. Where income prior to a tax-induced price increase is fully dedicated to consumption expenditure, there is no choice but to lower purchases (net tax) with respect to the amount of the tax-induced price increase. While many individuals and family groups through the middle income ranges are "living completely up to their incomes", this situation is most common in the lowest income ranges. Several recommendations can be put into place to change this current situation. Firstly, retail sales taxes can be exempted totally from foodstuffs and other necessities. This can have a social effect by easing the tax burden on lower income classes whom their budget comprises mostly of such purchases. Economic patterns can also be affected by such exemptions. This move will ensure that people of low-income level can access such goods at a cheap price and this will enable them to have some money left behind for saving. To substitute for this, governments should impose high sales tax for imported goods to ensure that its people purchase locally manufactured goods. When there is a high demand for local goods, this translates to high level of employment hence many people start paying taxes. Another recommendation is by avoiding multiple tax discrimination among commodities. A value added tax is so much imposed on various stages of production and distribution for various commodities and this tax burden is also embodied in the final retail price. Manufacturers excises can be framed so that the sale of goods that require further industrial processing are exempted and this will in turn prevent multiple taxation of some commodities in the course of their production. An item involving short chain of production and distribution bears much smaller sales tax when it reaches the consumers. This will be possible only through a provision for rebate of taxes that had previously been paid on resold commodities. It should be noted that this provision is not administratively applicable. When the cost of production is high, this affects the sales tax rate. The government should regulate on other levies imposed on production of goods to reduce cost of production. For instance, when high taxes are imposed on fuel, the cost of production will definitely rise and once the products get into the market, high sales rates will be imposed. Good transport network ensures that the cost of transferring goods from one place to another is low. The government should ensure that there is proper transport net network as this also ensures that supply of goods is constant. Delay in supply of goods increases demand. 7.0. Summary & Conclusions As a first approximation and based on absorption of the power to purchase by sales tax, it can be concluded that most revenue from a general sales tax constitutes a reduction of consumption expenditure. Shifting general sales taxes results to increase in prices and this tends to penalize saving. When prices increase, individuals who were spending to the limit of their incomes have no choice but to reduce their physical volume of spending since the purchasing power of their income is reduced. This is not the case with individuals of high-income range and who have a flexible margin of saving since can substitute the sales tax burden with the saving. A second estimation of the influence of a sales tax on saving and spending (national ), taking this penalization of spending into account, would allow the greater reduction of spending and less reduction of saving than the first approximation. People in the lower income will be expected in time to increase their spending while those in the higher-income may be expected to reduce their spending. In this case, margin for change might be relatively narrow for groups of low income as compared to those in the high-income group. This net effect will cause a sales tax to reduce spending at the end. The governments should control sales tax and be in favor of those earning low income. Reduction of sales tax to common goods will ensure that the low-income group has access to food, medical care, education and other essential necessities. 8.0. Bibliography Brederode, F.W., Robert. Systems of general sales taxation: theory, policy and practice Hong Kong: Kluwer Law International, 2009. Gerson, Philip. The impact of fiscal policy variables on output growth. Washington, DC: IMF, 1998. Hartley, James and Hoover, Kevin. Real business cycles: a reader. Washington, DC: Routledge, 1998. Hassett, Kevin and Hubbard, Glenn. Transition costs of fundamental tax reform. Washington, DC. American Enterprise Institute, 2001. Kanbur, Ravi and Spence, Michael. Equity and growth in a globalizing world. Washington, DC: World Bank Publications, 2010. Rajan, Ramkishen and Asher, Rajan. The macroeconomics of financing government expenditure: a survey of the static consequences. London: NUS Press, 1997. Schiavo-Campo, Salvatore and McFerson, Hazel. Public management in global perspective. 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