Taxation Overview

Taxation Overview
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Taxation Overview
INTRODUCTION
Justice Oliver Wendell Holmes Jr. stated, "Taxes are the price we pay for a civilized society" (Miller & Maine, 2010). Put in other simple but straightforward terms, ‘Taxation’ refers to the platform by which governments amass financial resources by imposing charges on the general public and businesses to cater for their expenses. Over time, governments have used taxation to advocate for or condemn some trends in economic activity. For instance, increment of tax on certain manufactured goods will discourage their consumption. Additionally, Taxation stands out as an important tool for income distribution among citizens of a country. It facilitates accumulation of funds to establish public goods and services e.g. roads and defense respectively for the good of all citizens. Hence, it can be correctly stated that taxation aims at revenue collection for public expenditure (García-Peñalosa, & Turnovsky, 2011). All the same, it is important to note that there exists a level of shortcomings in using taxation as a tool for income distribution within a country’s setting. This arises because of possibility of incredibly high effective tax rates that would discourage people from working considering a large portion of their earnings will be going to the government. Nonetheless, aside from having notable considerations about taxation of citizens, many policymakers are concerned with the different corporate tax systems existent in the world today. There has been witnessed numerous calls for reforms, especially in regards to international business. As such, it remains significant to review tax systems in both developed and developing countries and the impacts of specific policy options on crucial economic factors and consequently trade within and across borders.
THEORY AND BACKGROUND
This paper seeks to identify and review a number of theories relating to taxation and its impact on people, businesses and governments. One such theory is the Optimal Taxation Theory, which conceives that any given tax system ought to maximize citizens’ social welfare besides having a number of predetermined constraints. This ideology is termed as ‘Optimal Taxation’; it bears a ‘utilitarian approach’, wherein overall social advantage for the majority is of first priority. As such, beneficial utilities for public use should be distributed and supplied equally and without discrimination as a function of income distribution. In fact, the tax system developer (government) is viewed as social planner that has to consider the preferences of citizens as consumers of public goods and services in regards to policy making. As a case in point overview, the theory calls for visualization of members of the public as an economy filled with identical elements in terms of needs and preferences. Therefore, the social planner bears the responsibility of coming up with taxation policies that aim to maximize citizens’ social welfare by making use of tax incentives, which ultimately result in actions geared towards nation building even as citizens enjoy the fruits of their labor. Mankiw et al. (2009) explains the idea posited by Frank Ramsey (1927) that in case of taxation of commodity products, the process should engage inverse proportion taxing to correspond to elasticity of demand expressed by consumers. In other words, commodities with inelastic demand should be taxed more or heavily as opposed to those with elastic demand (García-Peñalosa, & Turnovsky, 2011).
A deeper analysis of optimal taxation theory reveals that ‘Flat tax’ involving lump-sum transfers can be regarded as optimal and that optimality of income distribution and redistribution is more likely to increase with inequality of wages, which form primary income for the middle class and the poor (Bird, & Zolt, 2013).
An analysis of data put forward by the Pew Research center (2012), indicates that the neo-Saxon world is highly characterized by people and entities of separate classes, particularly in regards of ability and effort to amass income. All the same, the middle and lower class in the developed world have been the most affected by taxation, in fact "the middle class has shrunk in size, fallen backward in income and wealth, and shed some—but by no means all—of its characteristic faith in the future" (Pew Research Center 2012). Furthermore, ever since the period from 1979 to late 2000s, the top income earners in the U.S. have witnesses the tripling of their income gains (Harris & Sammartino 2011). On the other hand, income for the middle class has increased for 40% and just 18% for the low class over the same period (Piketty and Saez 2013). All this is happening in the wake of a situation where in taxation policies are somewhat ineffective in regards of curbing inequality (Harris & Sammartino 2011).
In light of this, this paper aims to discuss forms of ‘Optimal Taxation’, which remains a critical objective for governments around the world. Mankiw et al. (2009), maintain that management of a country’s economic system ought to be characterized as a representative of the taxation imposed on citizens, who are consumers at the same time but still pay tax to the government in whatever ways there are (Timmons, 2010). An important approach to consider now is the Mirrlees framework, which posits that problems facing taxation are associated with inadequate information between the government and taxpayers. It is widely accepted that those taxpayers of greater ability and income ought to be taxed more to distribute income through mechanisms of public systems delivery, enabling low-income earners to lead sustainable lives. This in turn advocates for the "Revelation Principle", which calls for individuals to disclose their subject matters for taxation allowing for ‘optimal’ resource allocation. Overall, it comes out clearly that ‘Optimal Marginal Taxation’ reduces with increment of income.
Whenever ‘Taxation’ is under discussion, the ‘Lifeblood Theory’ is more than likely to come up. This ideology indicates that taxes are an indispensable factor for any country for it to operate. The theory emphasizes the fact that governments require revenues from taxation to cater for public expenditure and benefit society in ways that are essential (García-Peñalosa, & Turnovsky, 2011). As a result, countries with stable taxation systems are able to make reliable provisions for public goods and services for use by citizens. All the same, the lifeblood theory does not call for legal enjoinment of collection of taxes but maintains that taxation should not be a subject of compensation and or set-off. The theory also recognizes that taxation could result in violation of citizens’ property rights in cases where the objective of the tax collector holds little regard for social welfare.
On the other hand, there is the ‘Benefits-Protection Theory’ of taxation. This outlines a simplified thought that citizens of a country pay taxes to their government, which in turn guarantees the provision of benefits as public goods and services and direct protection of the citizens by the State.
Another theory of taxation is the ‘Necessity theory’ which provides that subsistence of a government is necessary in a country and so the incurrence of public expenditure (García-Peñalosa, & Turnovsky, 2011). Still, the theory recognizes that taxation could result in destruction of property just for the sake of catering for public expenditure- an ideology termed as "Marshall Dictum". On the other hand, it recognizes the "Oliver Wendell Holmes Dictum", which insinuates that taxation does not serve to destroy any property whatsoever since its scope is determined by the constitution (Miller & Maine, 2010). As such, this theory aims to reconcile the two stated ideologies by asserting that albeit the scope of taxation being seemingly unlimited, it should not be exercised via an arbitrary approach and that in cases where members of the public may feel aggrieved; they could seek resolutions through the courts.
ASPECTS OF TAXATION
One important aspect of taxation revolves around accounting for income tax. This is concerned with allocation of certain and predetermined tax burdens via approaches that are both intraperiod and interperiod. The former targets periodic retained earnings and net income while the latter is about apportionment of tax burden for financial accounting for a period of income or loss that could be a result of continuing or discontinued operations, extraordinary items, pension adjustments or other comprehensive income among others.
It is noteworthy that shares of taxes and tax ratios attributed to income tax have been on a steady decline in the United States and the larger North America region over the past several years (OECD, 2012). Still and as mentioned, taxation remains a most vital tool for governments...