Tax Elasticity

Anthony Cunningham
Microeconomics
Mr. G. E. Fitzgerald
October 17, 2012
Tax Elasticity and Tax Policy No matter what, taxes matter. People talk about them, complain about them, and try to dodge them when they can. Businesses also react to taxes, both in how they organize their activities and, perhaps, in where they carry them out. How people and businesses react in turn affects the level and structure of taxation. The purpose of taxation is to raise revenue to pay for public goods, but along the way it has impacts on economic growth and income distribution. These impacts are often undesirable, and sometimes difficult to predict. Tax policy is the most complex area of economic policy, because each tax change has so many ramifications. One can say very little about the impacts of taxation based simply on economic theory and deductive logic. Only empirical estimates of the elasticity of response to specific taxes can enable us to choose which is the least bad alternative. This empirical analysis is inherently difficult, and it is made even more difficult by the existence of an unmeasured underground economy. In business of producing goods for trade or selling, there are two measures of the sensitivity of buyers and seller to price changes that can play an important role in evaluating the effects of taxes for both sides. In demand of produces or services, elasticity measures the responsiveness of quantities demand of an item relative to changes in it price. Supply elasticity gauges the responsiveness of quantities supplied of an of an item relative to change in its price. Either one has a big impact on the cost of the items effectiveness.
In public finance, there are two important measures that have been used to assess the efficiency of any tax system in terms of its mobilization capacity are tax buoyancy which in definition is the total response of tax revenue to changes in national income and discretionary changes in tax policy over time; and tax elasticity automatic response of tax revenue to GDP changes less the discretionary tax changes (Prescott 4).
Tax incidence (the distribution of the tax burden among the buyers and sellers in a market) depends on the elasticity of demand and supply because elasticity measures the buyer and seller's willingness to leave the market when the prices of goods change. The more elastic demand/supply is, the more buyers/sellers will leave the market when the prices rise.
Therefore, the tax burden falls more on the side of the market with the smaller elasticity, because a small elasticity means that more buyers/sellers remain in the market when the prices rise due to their being fewer available alternatives.
One principle that all those on the left hold is that taxes constitute more than an economic issue; they are, first and foremost, a moral one. So many economists argue for higher taxes on economic grounds but they and we know that at bottom, higher taxes, especially "taxing the rich," is what they believe morality demands. It is too bad that libertarians and conservatives rarely take on the moral grounds because the foundations are as weak as their economic foundations.
The very notion of an income tax is morally debatable. On what moral grounds can the state force a citizen essentially at gunpoint to give away his legally and morally earned money? Why isn't taxation a form of legalized stealing? The obvious answer is that common sense dictates that citizens have the moral right, even the moral obligation, to vote to give money to, at the very least, enable a government to fund a police force, sustain a national defense, and help those incapable of helping themselves or of being helped by others. But at some point beyond that, taxation becomes nothing more than legalized stealing. Obviously, people will differ over where exactly that point is, but no rational person disputes that such a point exists. No one could argue that a 100 percent tax -- even if it paid for every need every member of the society had -- was moral and not simply a form of theft.
So moral problem No.1 is with taxation is the morality of forcing other people -- under threat of violence -- to give their money away.
A second moral problem is having some people give at a greater percentage rate than others. From the biblical notion of tithing, for example, is entirely universal -- everyone gave a tenth what he had. No one was forced to give half while others gave a tenth.
A third moral problem is allowing those who pay no tax (such as the federal income tax) to vote on how much others will be forced to pay. It is quite difficult to morally defend the fact that about half of Americans pay no federal income tax, yet they determine how much the other half will be forced to pay.
A fourth moral problem is that the higher the taxes, the more decent people become cheaters. This can cause people to act in stranger ways than there are used to.
A fifth moral problem is that the higher the tax rate, the lower the charity rate. This is universally true. The more people give to the state, the less they give to their neighbor -- and even to members of their family -- in need.
And sixth, the higher the taxes, the less people are inclined to work hard. Why should they? At a given point, people just conclude that work is for suckers. The more you work, even if it was to be overtime, do want to. More money means more taxes.
There has always been some good question about the nation’s government and local government’s involvement on when should taxes be imposed and collected. Most economists have different theories and great advice about the situation and other believe there is no sensible solution insight.
A number of important taxation principles arise in the study of public finance. These principles provide insight into causes and consequences of government taxation. At the top of the list are the reasons or justifications for collecting taxes from members of society. The two key reasons are termed the revenue effect (generating revenue to financed government activities) and the allocation effect (using taxes to discourage particular production, consumption, or exchange activities).
Another important set of principles deals with the proportionality of taxes with respect to income, that is, what proportion of income is paid in taxes at different incomes levels. The three alternatives are proportional (equal proportion at every income level), progressive (a higher proportion of income at higher incomes), and regressive (a higher proportion of income at lower incomes).
Public finance is further concerned with the equity and "fairness" of who pays taxes and who should pay taxes. This leads to two noted principles -- the benefit principle (those who benefit from a good pay the taxes) and the ability-to-pay principle (those who have the income pay the taxes). When applying the ability-to-pay principle to types of equity warrant further concern -- horizontal equity (equal incomes pay equal taxes) and vertical (higher incomes pay higher taxes).
Governments first and foremost impose taxes as a means of generating revenue, what is termed the revenue effect. However, they also recognize that taxes can be used to alter the allocation of resources, what is termed the allocation effect.
For the tax effect governments first and foremost impose taxes as a means of generating revenue, what is termed the revenue effect. However, they also recognize that taxes can be used to alter the allocation of resources, what is termed the allocation effect.
Revenue Effect: The primary reason governments impose taxes is to generate the revenue used to finance the operation of government, most notably the provision of public goods. Governments need access to resources to build highways, defend the nation, educate the population, and maintain the legal system. They purchase these resources with tax revenue.
Allocation Effect: A second reason governments impose taxes is to change the allocation of resources. Because people would rather not pay taxes, taxes create disincentives to produce, consume, and exchange. If society deems that less of a particular good, such as alcohol, pollution, or cigarettes are "bad," then a tax can reduce its production and consumption, and thus change the allocation of resources.
While governments might impose taxes for one reason or the other, all taxes have both effects. A tax intended to generate revenue changes the allocation of resources. A tax intended to change the allocation of resources generates revenue. However, different taxes achieve the two effects to different degrees. Ideally, governments want revenue generated by taxes with little allocation effect. And when governments impose taxes to discourage a particular activity, success entails little revenue effect.
Sense anyone in America who has special types of jobs and does not pay taxes like a citizen working in the private sector, there are still some taxes that everyone has to pay.
A wealth tax is a tax which is levied on the wealth held by a person or entity. The tax rate is typically a percentage of the taxpayer's calculated net worth, but it can vary depending on total net worth and the taxing nation's specific laws. Several countries use this form of taxation to raise funds for the government, though arguments for and against this approach certainly exist.
Most wealth taxes around the world are based on net worth, which is typically found by totaling the taxpayer's assets, and then subtracting debts, such as loans and mortgages. Assets include cash deposits, real estate holdings, investments, trusts, and shares in businesses. Since wealth taxes mean that a nation's wealthiest taxpayers have to pay a proportionately higher amount in taxes than their poorer counterparts, it is considered a type of progressive tax.
In some areas of the world, a blend of wealth and income taxes can be found. In the United States, for example, taxpayers pay income taxes rather than federal wealth taxes; however, they may also be subject to other types of taxation like property taxes, which are taxes on the value of real estate, a type of wealth. As property tax revenues in many areas show, a wealth tax can be a very effective way to raise money, as people who hold valuable real estate investments can owe substantial property taxes annually.
The main purpose of taxation is to accumulate funds for the functioning of the government machineries. No government in the world can run its administrative office without funds and it has no such system incorporated in itself to generate profit from its functioning.
The main reason for taxation is to raise funds for various government projects. The aspects that most people are aware that are funded by taxation are items such as speed cameras as well as the emergency services. But, there are many other projects and ways that taxes are spent by the Government.
Other functions of taxation includes; expenditures on war, the enforcement of law and public order, protection of property, economic infrastructure (roads, legal tender, enforcement of contracts, etc.), public works, social engineering, and the operation of government itself. It also welfare and public services such as; education, health services, pensions and unemployment benefit.
Taxation is applied in many different countries around the world and each area has their own purposes of taxation and their own levels of taxes. When it comes to the purposes of taxation the four R’s are applied. These are: Revenue, Redistribution, Re-pricing and Representation. Each R symbolizes a different area that taxation is used for.
The first known system of taxation levels dates right back to the Egyptian times in 3000-2800 BC where the Pharaoh, if there was no money in the household, would take a part of everyone’s crops or produce. Since then there have been many more recorded examples of taxation; from the Bible to government records, taxation has, for the majority of our history, existed in one form or another.
Capital gains are profits from the sale of a capital asset, such as shares of corporate stock, a business, a parcel of land, or a piece of art. Capital gains are generally included in taxable income but are often taxed at a lower rate; under current law, for example, most long-term capital gains face a top rate of 15 percent. Complicated rules impose a range of tax rates on different kinds of gains and can make it difficult for taxpayers to calculate their tax liability.
A capital gain occurs when a capital asset is sold or exchanged at a price higher than its basis (its purchase price plus commissions and the cost of improvements net of depreciation). Similarly, a capital loss occurs when an asset is sold for less than its basis. Gains and losses (like other forms of capital income and expense) are all measured in nominal terms-that is, unadjusted for inflation.
Capital gains and losses are considered long term if the asset was held for over one year, and short term if held for a year or less. Taxpayers in the 10 and 15 percent tax brackets pay no tax on most long-term gains; under EGTRRA provisions, extended through 2012 by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, and taxpayers in higher brackets face a 15 percent rate on long-term capital gains. In 2013, when all the temporary provisions expire, those rates will revert to pre-2001 levels: 10 percent for those in the 15 percent tax bracket or lower and 20 percent for all others. Recaptured real estate depreciation (that is, gains up to the amount of depreciation deductions previously claimed) is taxed as ordinary income tax rates up to a maximum of 25 percent. Gains on art and collectibles are taxed as ordinary income up to a maximum 28 percent rate. The maximum rates apply under both the ordinary income tax and the alternative minimum tax (AMT). The figure shows how the maximum long-term capital gains tax rate has changed over the years.
Capital losses may be used to offset capital gains and up to $3,000 of other taxable income. The unused portion of a capital loss may be carried over to future years. Taxpayers may realize up to $250,000 of gains on their principal residence tax-free. Married taxpayers filing jointly may exclude up to $500,000 from tax.
The basis for an asset received as a gift equals the donor’s basis. However, the basis of an inherited asset is "stepped up" to the value of the asset on the date of the donor’s death. The step-up provision effectively exempts from income tax any gains on assets held until death. Assets inherited from people who died in 2010 (when the estate tax was repealed) qualified only for a limited step-up of $3 million for gifts made to a spouse plus $1.5 million for gifts made to anyone. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 allowed estates of people who died in 2010 to choose between the 2010 law and the 2011 law, under which heirs get full step-up in basis but the estate is potentially taxable. Individuals may exclude up to 50 percent of capital gains on stock held for more than five years in a domestic C corporation with gross assets under $50 million on the date of the stock’s issuance.
C corporations pay the regular corporate rates on the full amount of their capital gains and may use capital losses only to offset capital gains, not other kinds of income. Capital gains may face effective tax rates above the statutory rates because of phase-outs in the tax code. For example, taxpayers in the phase-out range of the AMT exemption incur an implicit surtax of 6.5 percent (for taxpayers in the 26 percent AMT bracket) or 7 percent (for taxpayers in the 28 percent AMT bracket)
Conclusion
Tax policy debates, more than most other areas of economics, have been driven by ideology rather than evidence. The level of taxation is at the core of the debate between those who want more versus less government participation in the economy, between collectivists versus individualists. Not too far behind the ideological debate is the battle over income shares and economic rents, and the reality that some of the most profound impacts of tax policy are on the distribution of income among different factors of production and different income groups.
However, for those who are interested in positive tax policy, it is possible to penetrate this fog. A great deal of good empirical research about the effects of specific kinds of taxation already exists, and this body of knowledge will grow as increased computer processing power gives researchers access to immense new databases