Macro and Micro Economic: Taxation - Assignment Example

Running head: MACRO AND MICRO ECONOMIC: TAXATION MACRO AND MICRO ECONOMIC: TAXATION By s City, State Date QUESTION 1 Tax is a compulsory contribution to the government revenue in the form of money levied by the government on its citizens. There are various reasons why the government may levy taxes on its people as explained below: First, government taxes its people to provide public services (Keen, 2012). Public services refer to the services provided by the government to its citizens without their contribution. There are numerous services provided by the UK government to it citizens such as; healthcare, national defense, social security and social services. In the recent years, UK has been providing the important services to its citizen. For example, the government ensures continuous training, equipping, and support necessary for its security and police personnel to ensure that there is good security to its citizens. The government had also been supporting the public schools to improve the educational level in UK. Another important service that UK has been providing to its citizens is provision of good health care to the UK citizens. The government had been providing support in the health sector in UK to improve the health of its citizens. All these important public services compel the UK government to impose taxes on its citizens so that its continuous providing these important services to its people. To the examples discussed, a government taxes its citizens so that it can provide the public services that cannot be provided by other people. Second, government taxes its citizens so that it can provide essential public goods to its citizens. These are those goods that cannot be provided by other individuals because of their high costs of production or because the provision leads to the benefit others unfairly. For example, the UK government taxes its citizens so that it can build streetlights, which is can be enjoyed or used by any UK citizens. In recent years, UK ensures that the streetlights function properly and thus taxes the public and use this to cater for installation and maintenance of these streetlights, which goes for other commodities, as well. The UK government also ensures continuous maintenance of the public roads, and other infrastructural facilities used by its citizens. The maintenance of these roads requires a significant amount of capital that the government can only raise through taxing its citizens. Therefore, government taxes its citizens to provide those essential public goods such as roads and streetlights, which are highly essential for the citizens. Third reason why the government taxes its citizens is to reduce or compensate for the negative externalities. These are negative actions or external cost on third party caused by transaction by individuals or organizations in the society. To deal with these externalities, government imposes a tax on those responsible for these externalities or on the goods that are produced, which results into the cause of the externality. For example, the UK government imposed tax on tobacco manufacturers so that it could use the money to reduce the effect of tobacco smoking on its citizens. Fourth reason is that the taxation is used as a fiscal policy. Fiscal policies are used to rectify the macro environment of the economy in a short-term basis. The government imposes a tax on its citizens to expand or contract the economy. Expansionary policy is aimed at growing the economy; hence, increasing employment and contractionary policy is aimed at reducing the growth rate of the economy (Bradford, 2012). When government wants to increase the economic growth, it reduces the tax rate, but when the aim of the government is to reduce the growth due to high inflation, it increases the tax rate. Therefore, taxation is one of the factors of the fiscal policy that the government considers when it wants to rectify its economic environment in the short run. For example, UK government increased the level of tax rate to its citizens so that it could fix the high level of inflation in the country. Therefore, the government taxes citizens to rectify economic situations in the country through its fiscal policies. Finally, government taxes its citizens to pay public debts. Governments incur debts when their spending level is more than their receipts from the taxes and other revenues sources. For the governments to pay these debts, it has to tax its citizens. Therefore, payment for the borrowed fund by the governments is one of the reasons that compel the government to tax its citizens. For example, UK incurred a debt of £1.1 billion through selling bonds to the investors, which are currently paid through tax paid by the citizens. QUESTION 2 This part of the essay evaluates the economic effects of a cut in direct taxes for both individuals and firms in the UK while considering both costs and benefits. A cut in indirect cost has various benefits and costs as explained. The benefits to the individual and the firms are: To begin with, tax cut is an economic stimulus during the recession period, a period that the economy is underperforming. When tax cut is introduced in the economy during this period, the economic productivity will be stimulated as most people will spend more of their income in consumption due to their increased purchasing power in the economy. More consumption of the goods produced in the economy will increase the level of production; hence, more output level in the economy. Additionally, tax cut will increase the level of employment in the economy. This is because more people and the firms will be willing to invest as their level of income is increased due to the tax cut. Increase in level of employment in the economy increases the rate of employment and therefore the rate of unemployment in the UK economy is reduced. Similarly, increased level of saving in the economy is another benefit that will accrue to the UK economy due to the tax cut. When there is a tax cut, the level of the income to the household in the UK also increases, and, therefore, this results in more saving. Increase in saving will increase the level of investment, as there will be enough money in the economy for people to borrow and invest in UK. Cutting corporate tax can attract foreign direct investment DeMooij (2003) in the UK economy. Increase in the degree of foreign direct investment in the UK due to the cut in the corporate tax can improve the economy of the country through increase in output level; hence, increased revenue and creation of employment opportunities for the UK citizens. The increase in foreign direct investment in UK will increase the level of revenue, which can be used to develop other sectors such as infrastructure in UK. A cut in the corporate tax creates a benefit to the low-income earners through reduction on the tax burden that they have to bear. This is because most of the corporate taxes are shifted to the consumers who use the final products in the form of increased prices. A cut in the corporate tax will lead to a reduction in the prices of goods and services produced by the corporate companies. This further will make the consumers pay less for the products hence reduction in the tax burden. Further, a cut in direct taxes LaFaive (2012) for both the individuals and the corporations promote higher long-term economic growth. A tax cut will retain the foreign companies to continue with their operations in UK, attracts more organizations to the economy, and increases the level of investment and productivity. These will promote the long-term growth of the UK economy in the various sectors such as development of the infrastructures, increase in the level of technology, proper education to the UK citizens and long-term employment. Tax cut to the individuals in UK will improve their living standards. This is because the tax cut ensures higher wages to the to the citizens, and; therefore, high living standards as most of the citizens can afford a wide range of the goods, good housing and proper clothing. Most people will have proper feeding habits when there is a tax cut due to increase in income level. Therefore, the UK citizens will have improved living standards and good health standards. The other benefit of a cut indirect tax is the improvement in UK competitiveness. Various countries compete in terms of the total output sold in the market and the quality of the products sold in the world economy. A cut in the corporate tax will reduce the prices of goods and services sold in the global market as the cost of production of these products is reduced through a cut in direct tax. This will make the UK products competitive in the world market, as they will have low prices as compared to those of other countries. Therefore, the UK products will have a good market share, as most consumers will prefer the less costly goods in the market hence putting the country in the competitive hedge. In addition, cutting corporate tax to the corporate lowers the corporate debt and lowers the incentive for income shifting in the UK economy. The unpaid corporate tax is a form of debt by the corporate to the government. Therefore, cut in the corporate tax reduces the level of these debts owed by the corporate. A reduction in the level of debt to the corporate increases the level of wealth to the company’s shareholders, and, therefore, increases their investment level in such organizations. Lastly, cutting direct taxes for individuals and the corporate can increase incentives to work. Lower direct taxes can encourage people to work longer hours because more income will be retained as the amount taxed from those longer hours is low and encourage new people to enter the labor market. Lower direct tax will encourage companies to invest in the country hence more incentive to work in such an economy. On the other, hand a cut in the direct tax for both individual and the corporate has some economic costs such as: First, decrease in the real income of the government. A cut in the direct tax to the corporate and the individuals reduce the amount of revenue that accrues to the government. This means a reduction in the government budget will have to reduce because of the reduction in the available revenue. The reduction in government budget can result in a reduction in the provision of essential commodities and services to the public. When the government stops providing for some of the essential products to the public then the citizens and the corporate have to bear the costs such as road maintenance, and installing streetlights. Second, direct tax cut will increase the national debt. Direct tax cut reduces government’s income, and, therefore, results in the budget deficit as less revenue is generated from the tax due to the tax cut; this will make the government borrows more from other countries and investors to finance the deficit. For these debts to be paid, it must come from the tax imposed on the citizens. Therefore, this will cost the citizens in future, as they will have to be taxed high to repay the debts. A cut in direct tax as a future cost to individuals and the corporate as a whole this because any service or goods provided by the government to its citizens through borrowing must be repaid by imposing high taxes on the same citizens who received the benefits. Third, cut in the direct tax can lead into inflation. When there is a tax cut in the economy when the economy is in a stable state, it can result into inflation. This is a situation where too much money is chasing very few goods. When the purchasing power of the citizens increases due to the cut in the direct tax more goods will be demanded in the economy. Thus when there low respond to such demands, the prices of goods will increase leading to an increase in inflation in the economy. This will be a cost to the citizens, as they have to spend more money in consuming a product than it was before. Fourth is the increased inequality in the economy. Cutting direct taxes can lead to the danger of increasing inequality in the country because a lot of government spending is targeted on citizens of lower income groups. This will increase inequality, as the high income earners will have to pay for the low-income earner through the services rendered by the government to these low-income earners. Fifth, cutting direct taxes rarely increases incentives, but instead, may induce people not to work more. This is because they fill that a cut in the direct tax will have both the income and the substitution effect in the end, and, therefore, does not have any effect on the supply side of the economy, but increases the government spending. Therefore, the cost is that when there is a cut in indirect tax people do not necessarily work more, and the cost is left to the government. Lastly, cut in direct taxes to the individuals and corporate may increase health cost to the citizens. Taxes are used to discourage spending on demerit goods. Therefore, cut in the direct tax will lead into an increase in the purchasing power of the consumers and low prices from the producers of these demerit goods such as alcohol and cigarette; hence, more can be consumed resulting into health effects, which in the long run will cost both the government and the citizens. In conclusion, cut in the direct tax by the government has both benefits and disadvantages as explained above. Therefore, tax in general has a beneficial effect to the citizens of a country. Hence, governments should tax its citizens to provide these crucial services, but it should be at a reasonable rate. References Bradford, D.F., 2010, “The Incidence and Allocation Effects of a Tax on Corporate Distributions,” Journal of Public Economics Vol. 15(1), pp. 1–22. De Mooij, R.A. and S. Ederveen, 2003, “Taxation and Foreign Direct Investment: A Synthesis of Empirical Research,” International Tax and Public Finance Vol. 10(6), pp. 673–93. Keen, M., 2012, “Preferential Regimes Can Make Tax Competition Less Harmful”, National Tax Journal Vol. 54(2), pp. 757–62. LaFaive, Michael, 2012, Tax Cuts vs. Government Revenue, New York: Mackinac Center for Public Policy. Read More