State Taxes and Economics - Case Study Example

Name WITHIN THЕ ЕURОРЕАN UNIОN, LОWЕR TАХАTIОN RATES РRОDUСЕ HIGHЕR ЕСОNОMIС GRОWTH. Course Lecturer University Date Introduction The phenomenon of economic association between spending, economic growth and taxes creates Keynesianism and Keynesian economics. This phenomenon dominantly regulates the macroeconomic theory since 1970. Keynesianism relates to the tax policy and further stresses on tax rates adjustment. These adjustments however depend on whether higher taxes are encouraged in the economy in order to pay off debt and fund long term expenditures. Governments need to lower taxes during bust cycles. Additionally, the particular governments need to consider engaging in deficit spending and counter recessionary spending and saving which make recovery difficult (Poulson & Kaplan 2008, 2). High end spending during recessions could lead governments to inject capital into the economy by creating temporary jobs. High taxes during expansions on the other hand could enable the government to recover the deficit spending incurred during recessions. Application of this phenomenon of counter scheduling enables smoothening of boom and bust cycles which ultimately promote gradual economic growth (Poulson & Kaplan 2008, 6). Reaganomics and into the 21st Century The Keynesian economic model of spending and taxes still applies thirty years following the Great Depression in the United States. Nevertheless, during the 1990s, the beginning of stagflation: the stagnant economy, devalued currency and inflation stalled the United States economy. Subsequently, the Keynesian model faced intense criticism and a new model known as the Supply Side Economics emerged. The Supply Side Economics relates to tax policy and notes that tax rates need to be lowered. The model further stresses that low tax rates could enable the government to manipulate the economy and create more jobs than government spending (Matthews, 2013 (n.d)). . By leaving money in abundance in the free market, the economists expect a more efficient spending which could lead to higher individual economic status. Additionally, the Supply Side Economics argues that a revenue maximizing instance exists where individual and corporate taxes raise the maximum revenue for the government. Taxing at any point above the equilibrium could impact business growth negatively and also reduces revenue. As illustrated in the Laffer Curve introduced by Art Laffer, the revenue maximizing tax rate at point t. The curve rises from 0% tax rate which symbolizes lack of government constraint to 100% tax rate where the business is fully constrained (Matthews, 2013 (n.d)). Wealth, unlike Keynesianism, cannot be redistributed across the government programs. Alternatively, the Supply Side Economics apply the trickle-down effect which presumes that high economic growth could be harnessed by lowering taxes among the high and middle income earners who would increase their spending (Matthews, 2013 (n.d)). In depth reviews on the different methodologies applied in measuring the impact of taxes on economic growth raises many insights. First, it becomes clear that most of the variables used as independent, dependent and control variables may be susceptible to endogeneity. Studies by Plaut & Pluta (1983), Deskins & Hill (2010) and Mofidi & Stone (1990) used broad measures like total state revenues such as independent variables could be alternatively be used as dependent variables in the event that state revenue occurs as a factor of economic growth. Since revenue arises from taxes, if used as an independent variable, revenue could be endogenous with other spending and tax control variables (Georgellis & Wall 2006, 4). Therefore, upon deigning a regression experiment on the subject, one needs to be aware of how the particular variables identified associate with each other and account for various economic and tax factors in such a way as to avoid endogeneity. Other studies within the same scope conducted previously made diverse findings. This outcome could be attributed predictably to the wide variety of dependent, independent, control as well as other variables used to assure the effect of taxes on economic growth. Most of the studies conclude that taxes negatively affect economic growth. Upon doing a literature review, most of the studies do not qualify their results meaningfully by quantifying the connection between economic growth and taxes. They further fail to illustrate models that describe the effect of tax policy on the rate of economic decline or growth. Generally, expenditures bear as much effect on economy like taxes (Georgellis & Wall 2006, 7). Taxes impede on economic growth since it removes capital from the economy in accordance to the supply side economists. However, wise expenditures could return the revenue to the economy according to the Keynesian model. For instance, Papke & Papke (1986) made findings that economic growth automatically occurs when the government lowers taxes but maintains the level of services. Generally, this strategy of spend-and-spend mentality could result in national deficits in the event that economic growth fails to raise the tax revenue in order to make up for the difference (Canto & Webb 1987. 7-12). With the facts raised above, it appears that more spending highly benefits the economic growth. However, not all spending can be deemed equal. When taxes are paid by individuals or corporates, a decrease in their particular income occurs. Tax rates as well as tax policies vary widely by state but some associated variables remain constant. Four of most common and vital taxes such as personal income tax, corporate tax and property tax occur constantly as percentage of cumulative state and local revenues (Canto & Webb 1987. 7-12). Taxes=f(% Revenue from State and Local sales tax, % Revenue from State and Local personal income tax, % Revenue from State and Local property tax, % Revenue from State and Local corporate tax, % Revenue from Charges and fees) On the other hand, spending establishes services for consumption by residents. Additionally, these services provide direct or indirect benefits for the residents. Government spending especially on infrastructure a projects could boost the quality of life and working conditions in a particular state (Canto & Webb 1987. 7-12). Spending=f(State and Local Expenditures per capita, % State and Local expenditures on capital , % State and Local expenditures on welfare) Alternatively, labor factors besides spending policies and state tax create differences in labor market factors which need to be controlled as well. The level of education, demographic statistics and diversity in labor laws from different states result in inequalities which affect personal income per capita (Canto & Webb 1987. 7-12). Labor Factors=f(right-to-work, % state residents with less than a high school degree,percent under 18 years of age, percent over 65 years of age, minimum wage) Yit = αi + β1 ӿ spending per capita + β2 ӿ property tax % revenue + β3 ӿ Sales tax % revenue + β4 ӿ income tax % revenue + β5 ӿ Corporate tax % revenue + β6 ӿ Xit + Yeart + Ɛit (Canto & Webb 1987. 7-12) Various literatures on labor supply and responses from taxation across different countries can be acquired dating back to the 20th century. Additionally, various surveys were conducted on taxation among multinational corporations as well as capital mobility which create mobility effects; for instance, surveys conducted by Gordon and Hines 2002 and Griffith, Hines, and Sørensen 2010. However, very little empirical surveys exist on the effect of rates of taxation on spatial mobility especially among high-skilled workers (Deskins & Hill 2010, 5). Microeconomic Underpinnings Theoretically, economists understand the kind of effect that taxes make on the state economy. With an increase in taxes, the supply and demand of labor markets and products decreases. Taxes raise the prices of labor and goods above the natural equilibrium. As a result, most of the consumers do not afford the products and therefore this reduces the overall benefits. Additionally, this creates a deadweight loss in the market. The higher the tax, the more serious these effects become. On the figure below, we discuss graphically on this theoretical knowledge with price comparing with quantity. Pe represents the natural equilibrium price and Pc represents the new equilibrium price after taxes (Georgellis & Wall 2006, 4). Adapted from Yoong, Wei. (2012). Hybrid Revolution. When corporations move, so does the employment; the most vital factor for economic growth. For instance, when a major company such as Apple Inc. shifts from Europe, the European economy would experience a decrease. This would be the outcome since the company moves profitable employment along with it. High or Low taxes do not only influence the spending decisions of the companies, it also affects the wealthy individuals who contribute significantly to the economic growth. The cumulative consequences of all this are a loss of potential jobs, income and investment in the region depending on the tax rates with higher taxes (Matthews, 2013 (n.d)). In conclusion, in the contemporary world, high tax countries like Europe resent tax competition from other countries. Over the years, investors have been shifting their savings to low tax jurisdictions like Switzerland and the United States. This inflow of money could be attributed to the high standards of living among the Americans and general economic prosperity. Currently, Europe being a high tax country has been attempting to influence the World Trade Organization to compel United States to improve some of the provisions in its tax code so as to reduce tax competition. Clearly, Europe suffers tax evasion due to its high rates. Taking France as an example, most of its revenue arises from roughly twenty five thousand talented individuals. Additionally, the tax rates in France are reportedly seventeen percent above other developed countries. To avoid tax evasion or loss of revenue, France needs to lower its taxes and emulate Ireland. Currently, Ireland provides the second highest quality of life in the European Union (Poulson & Kaplan 2008, 2). References Canto, V. & Webb, R. (1987). The Effect of state Fiscal Policy State Relative Economic Performance. Retrieved from: http://www.jstor.org.proxy.lib.csus.edu/stable/pdfplus/1058814.pdf Deskins, J. & Hill, B. (2010). State Taxes and Economic Growth Revisited: Have Distortions Changed? Retrieved from: http://web.a.ebscohost.com/ehost/pdfviewer/pdfviewer?sid=f135119b-4977-4273 a75f3d3b220099b%40sessionmgr4002&vid=2&hid=4109 Georgellis, Y. & Wall, H. (2006). Entrepreneurship and the Policy Environment. Retrieved from: http://research.stlouisfed.org/publications/review/06/03/GeorgellisWall.pdf Matthews, D. (2013). Britain is Doing well on Employment Despite the Crummy Economy Why? Retrieved From: http://www.washingtonpost.com/blogs/wonkblog/wp/2013/06/16/the-uks-doing well-on employment-despite-a-crummy-economy-why/ Poulson, B. & Kaplan, J. (2008). State Income Taxes and Economic Growth. Retrieved from: http://www.cato.org/sites/cato.org/file s/serials/files/catojournal/2008/1/cj28n1-4.pdf Read More