Lwr Ttin rdus Highr nmi Grwth - Case Study Example

Lоwеr tахаtiоn рrоduсеs highеr есоnоmiс grоwth name: Institution name: Introduction The idea that taxes affect the economic growth has been politicised and the subject of much debate is founds among the advocacy groups and in the press (Engen et el, 2004). That is in part because there are competing theories about what drives the country’s economic growth (National Statistician, 2013). Some people have been found to subscribe to Neo-classical, supply side factors, while other have been found to subscribe to Keynesian model, demand side factors, while other people have been found to subscribe to some mixture of the two models or something entirely unique (Elmendorf et el, 2002). The facts, geographical and historical variation in key characteristics for example, should shed more light on the argument (Engen et el, 2004). However, the economy has been seen to be sufficiently more complex that virtually any theory is seen to find some support in the data. For example, Congressional Research Services (CRS) have argued over the years that theory that taxes have no major effect on economic growth by looking at the United States experience after the world war two. They further argued that fastest economic growth that occurred in the 1950s in the U.S (Elmendorf et el, 2002). when the country’s top rate was more than 90 per cent. However, their research study ignored the basic problems with such a statistical analysis, including: variation in the tax base to which personal income tax applies; the variation in other taxes, such as corporate tax, the long-term versus short-term effects of tax policy (National Statistician, 2013); and reverse causality, whereby the growth in the economy affected the tax rates (Favero, 2009). While there are many data sources and methods, the results consistently point to significant negative impact of taxes on economic growth even after various factors are controlled such as business cycle conditions, monetary policy, and government spending. Reduction in income tax rates Reductions in income tax have been found to affect the behaviour of businesses and individuals through both substitution and income effects. The positive impact of tax rate cuts on the economy arise because lower tax rates have been noted to raise the after-tax reward to saving, working and investment through substitution effects. This is typically the effect of tax cut on the country’s economy (Elmendorf et el, 2002). Another positive effect of tax rate cuts is that it induce an efficiency-improving shift and reduce the value of existing tax distortions in the composition of economic activity away from the tax-favoured sectors, such as housing and health. But tax rate cuts will also provide a positive wealth (or income) effects, which reduce the need to save, work, and invest (Favero, 2009). It will also raise the marginal return to work, at same time, reduces the value of the existing tax subsidies and this would alter the composition of economic activities (National Statistician, 2013). It will also raise the household’s after tax income at every stage of labour supply (Engen et el, 2004). This in return will reduce the labour supply through the income effect (National Statistician, 2013). For example, if the tax rate is 90 per cent, a reduction of 10 per cent in taxes will double after tax wage from 10 per cent to 20 per cent in the pre-tax wage. The graph below shows revenue as a percentage of Gross Domestic Products (GDP) since 1980-1981. Since 2013 it has continue to increase following the economic slowdown in 2007 (National Statistician, 2013). Receipts as a proportion of Gross Domestic Products (GDP) has stood at 15.6 percent in 2013 as compared to 17.3 percent in 2008 (Favero, 2009). This fall has been attributed to the reduction in economic activity and some structural changes such as increased individual allowance. The revenue in 2010-2011 also include bank payroll tax receipts. Fig 1: Income Tax receipts, 1980-2014 Tax Reform Tax reforms can be defined as a reduction in income tax rates as well as those measures that broaden the tax base (National Statistician, 2013), that is to say, to reduce individual’s tax expenditures or other items that have been found to narrow the tax base (Favero, 2009). Through the removal of special treatment of consumption or income, base broadening is seen to raise the average effective marginal tax rates on saving, labour supply and country’s investment (National Statistician, 2013). This has been found to have two major impacts: the substitution effect is seen to be smaller from an income neutral or a revenue-neurtal tax reform than from a tax rate cut. This is because lower tax rate has been found to raise the tax incentives to begin to work, and so forth (Engen et el, 2004). While the tax base broadening has been seen to reduce such incentives; and the average income effect that is realised from a income neutral or revenue neutral should be zero. Income base broadening has been seen to have an additional effect that has been found to help expand the size of the country’s economy (National Statistician, 2013). Specifically in the U.K it has reduce the allocations of resources to industries or sectors that are currently seen to benefit from generous tax cuts or special treatment. A broader based system with a flatter income tax rate has been found to encourage resources in the UK to move out of currently tax preferred industries or sectors and into those areas of the country’s economy that have higher pre-tax returns (Elmendorf et el, 2002). The reallocation has been found to increase the size of the country’s economy. Moreover, revenue losing business tax reform will result in reduction in capital or income for a shorter time, for a longer time it have been seen to boost deficits (National Statistician, 2013), while lowering the net country’s saving and thus it able to offset any other tax incentives that would be created for greater investment (Engen et el, 2004). In fact, many models have shown that the cost of higher deficits have be found to be associated with unpaid for corporate tax reductions and this has been found to outweights any potential efficiency benefits of the tax cuts themselves-leaving the level of output lower as a result. Financing Beside the effect on private agents, tax changes have also been found to affect the country’s economy through those changes that are found in federal finances (Elmendorf et el, 2002). If there exist changes in the income-neutral, there will be no issue with financing effects, since a reformed financial system would be able to raise the same amount of income or revenue same as an existing financial system (Favero, 2009). However, any tax cut should be financed by a combination of future spending cuts. The necessary policies changes may sometimes not specified in the original tax rate cut laws, but they have to be present in some form in-order to be able to meet the country’s budge constraint (National Statistician, 2013). Therefore, in the absence of spending changes, tax cuts may raise the federal budget deficit. Conclusion Both changes in the structure of the tax system and changes in the level of revenue have been found to influence the economic activities, but not all tax changes will have a positive effect on a country’s economic growth rate (Elmendorf et el, 2002). The argument that lower income tax rates will raise growth has been repeated so many times, and in some cases taken as a gospel truth. However, evidence, theory and simulation studies have been found to tell a different story (Favero, 2009). Tax cuts have been seen to offer the potential to improve the economy through the improvement on incentives to work, save and invest. But also its effect have been seen to reduce the need to engage the need in productive economic activities, and it may subsidize old capital which may provide a windfall gains to asset holders and in turn undermine the incentives for new activities (National Statistician, 2013). In addition, tax cuts as a standalone policy has been seen to raise the UK’s budget deficit (Favero, 2009). And this in return has been sent to reduce the national saving and raise interest rates, which has been seen to negatively affect the investment (Engen et el, 2004). Therefore the net-effect of tax reduction on the country’s economy is thus theoretically will depend on both the structure of the tax cut itself and the timing and structure of its financing. References Elmendorf, Douglas W., and David Reifschneider. 2002. “Short Run Effects of Fiscal Policy with Forward-Looking Financial Markets.” National Tax Journal 55 (3): 357-86. Engen, Eric, and R. Glenn Hubbard. 2004. “Federal Government Debts and Interest Rates.” Cambridge: National Bureau of Economic Research Working Paper 10681. Favero, Carlo, and Francesco Giavazzi. 2009. “How Large Are The Effects of Tax Changes?” Cambridge: National Bureau of Economic Research Working Paper 15303. "National Statistician – Director Office for National Statistics", 10 Downing Street press notice, 4 August 2005. Retrieved 9 June 2013. Read More