POWER OFGOVERNMENT TAX SYSTEM AND FISCAL POLICY
Power of Government Tax Systemand Fiscal Policy
Power of Government Tax Systemand Fiscal Policy
The role of the government inthe economy is both obvious and complicated. An average citizen canbe able to enumerate the functions of the government in the economy.Some economist argues that the government is a major player in theeconomy, while others have a contrary view. Nonetheless, thegovernment has an influence on business activities within itsjurisdiction. There are many ways through which the government isvisible in the economy. Some of the main roles include monetarypolicies, bailouts and subsidies, incentives and corporate taxes. Thegovernment is involved in the economy as a regulator and to correctrevenue. The revenue collection strategies are mainly contained inthe fiscal policy. Through the fiscal policies, among others, thegovernment has immense powers in the economy. This essay looks at howcorporate taxes, subsidies and incentives from the government impactson the economy.
Taxes are one of the mostimportant fiscal policies that have direct impact on the economy. According to Rothbard, (2006), the government is a large spender.Therefore, there are fiscal policies that are aimed at generatingincome for the government. The two main sources of income for thegovernment are taxes and inflation. Taxation refers to the leviesthat the government collects from individuals as well as businessorganizations. On the other hand, inflation income can be consideredto be a ‘fraudulent’ income where the government earns from newmoney. The government can significantly influence the economy throughtaxation policies. Rothbard, (2006) identifies two groups ofindividuals involved in the tax regime. The first group is burdenedby taxation policies while the second group benefits from taxes.Failure to pay taxes is punishable by law, it is a legal obligation.Taxes can be either direct or indirect taxes. There are several typesof taxes in modern taxation systems. They include income tax (whichmay include individual or corporate tax), property tax andaccumulated capital tax among others. While all the taxes levied bythe government have an impact on the economy, the most significanttax on the economy is corporate tax (Rothbard, 2006).
Corporate taxes within acountry have an influence on the rate of investment. This affects thegross domestic income and therefore the performance of the economy.Corporate tax includes all levies by the government on capital orincome to all corporate organizations. International corporatetaxation has more profound impacts on the economy. This is because itinfluences the location of production units by multinationalcorporate bodies as well as the ability of the economy to attractcapital investment. According to Mirrless (2010), there isdocumented evidence that indicates that multinational corporateorganizations are respond to tax codes within a region or country.Majority of studies have revealed that “the corporate tax basereflects the return to capital invested in the corporate sector”(Mirrless, 2010 p 1014). Thus a fiscal policy that increases thecorporate tax is aimed at discouraging capital investment in thedomestic economy. These fiscal policies are aimed at increasinggovernment revenue as a result of increased return of capitalinvestment in the economy (Seligman, 1899). However, economists arguethat this is likely to negatively affect the economy in the long run.Rather than increasing corporate tax, which discourage capitalinvestment, fiscal policies should be aimed at expanding the tax baseby encouraging more capital investment. For example, “normal returnto capital” can be exempted from taxation. This is through a fiscalpolicy that makes financial income form capital non taxable. Thisfinancial income includes interests, capital gains and dividends.This will encourage more investment, expand the tax base and thusincrease tax revenue to the government. The increased capitalinvestment will result into a series of benefits to the economy.Investment by multinationals will increase competition in the localmarket, and consequently the quality and variety of goods in themarket. New corporate within the economy will also increaseemployment opportunities, thus disposable consumer income. This willculminate into increased demand for consumer goods and economicstability (Mirrless, 2010).
According to Mirrless (2010),there are other corporate tax policies that have a negative influenceon investment by multinational companies in the domestic market.Under territorial corporate taxes polices, “profits are taxable tothe extent that they arise from capital invested in the domesticeconomy regardless of the location of the owner of the capital”(Mirrless, 2010 p 1013). This is as opposed to the resident basedtaxation policies where only domestic residents are taxed,irrespective of location of the capital. Economists argue thatterritorial corporate taxation policies will hurt the economy,especially in countries with significantly low influence on theglobal capital market. This is because huge investors tend to locatetheir capital investment in other countries until the profits beforetaxes have increased significantly to offset the taxes. Additionally,these investors tend to offer lower wages and salaries. Thesepolicies with negatively affect the economy since it is unattractiveto capital investors and hurts the labor market. Even in largeeconomies such as the United States, attempts to tax foreign sourcesof income have been ineffective. Academic sources indicate that theeconomy loses as results of territorial corporate tax policies sincefirm are able to avoid or postpone the taxes indefinitely in largeeconomies. In smaller economies, the tax policies will discouragecapital investments (Mirrless, 2010).
The opportunity cost ofsubsidies in an economy has been debated by scholars for many years.One school of through have strongly argued for a free marketindependent of government influence while some scholars have arguedin favor of government incentives. Nonetheless, incentive policiesare some of the ways the government has been able to influenceeconomic activities in a country. Proponents of government incentiveshave highlighted some of the goods produced or employmentopportunities available in some sectors which would be dead withoutgovernment incentives. This is due to the low revenue accrued fromthese sectors, the location of units of production or the capitalinvestment required. Although there is a disagreement on whatconstitutes a government subsidy, they agree on the first degreefixed impact. However, this is determined by a wide range of factors,which includes how the market (producer and consumers) respond, theconditions of the subsidy and the form in which the subsidy isextended. For example, in a producer’s market, a subsidy by thegovernment will be shifted onwards to the consumers. Proponents ofsubsidies as an economic policy have made reference to the impacts ofgovernment subsidies on the supply and demand elasticity in bothproducers and consumers market. On the other hand, subsidies aimed atenergizing some sectors in the economy have a distortion effectssince they divert resources from more productive sectors to lessproductive sectors of the economy.
Some economics have viewedgovernment subsidies and their effects on the economy as a politicaltool rather that a fiscal policies. This explains why governmentshave continued to resort into subsidies despite the widely publishednegative economic impacts. According to Rothbard, (2006), wealth canbe attained through political means or economic means. Economicmeans are applicable in a free market that is driven by marketforces. Corporate organizations are able to earn profits if thetarget clientele is willing to pay for their goods or services.Government subsidies distort the balance in the market driveneconomy. Subsidies enable the government to enable some individualsin the market to gain undue control and generate wealth. Some criticsof subsidies have argued that subsidies are an attempt by thegovernment to punish the efficient corporate in the economy whilerewarding the inefficient actors. Rothbard, (2006, p 209) argued that“subsidies prolong the life of inefficient firms at the expense ofefficient ones, distorts the productive system and hampers themobility of factors from less to more value productive locations”.The rationale of a market driven economy is to satisfy the demand ofconsumers by supplying goods at a cost. A subsidy driven market isnot demand supply driven since there is no full consumersatisfaction. For example, why should the government sustain a lossmaking enterprise while the proprietor can shift the factors ofproduction to a more profitable sector of the economy? (Rothbard,2006).
Rothbard, (2006) argues thatgovernment subsidies are an archetype shift from economic means ofaccumulating wealth to political means. Transferring taxes from onecorporate entity or individual to another will kill the economy sinceevery one will rush for political power rather than working hard tobe successful in business. A move towards generalized subsidies willforce individuals to divert their attention from production topolitical struggles. The diversion of economic energy to politics andthe government overburdening the efficient firms with the incubus ofthe poorly performing economy will have long term negative effects onthe economy. Through political influence, the inefficientindividuals in the economy are able to obtain a legal claim to becarried by the hard working and more efficient individuals in theeconomy. In this regard, those who receive subsidies will perfecttheir predatory skills while the inefficient will inevitably tend tobe more efficient. Economists have argued that all subsidies in thebusiness environment, including monopoly privileges given to somefirms promotes inefficiency. Perhaps, subsidies to individualconsumers rather than the producer may make sense to some economists.However, critics of economic subsidies have a different view.According to (Rothbard, 2006), economic subsidies to the poor throughfinancial and supplies relief has negative consequences. This isbecause poverty subsidies entitle the individuals affected to supportfrom the government. This increases idleness and poverty since theutility of income diminishes. In the long run, increased povertyresults into increased poverty subsidies. For the economy to pay forthese subsidies, the government has to extract resources from theincome earners. On the other hand, if the poor are supported by theincome earners through charity, they will not be entitled to it andtherefore the effects may be different.
Incentives and Disincentives
The government can influencebusiness activities in an economy through fiscal policies thatpromotes or favor particular business. These are policies arereferred to as incentives. They include cash or near cash supportgiven by the government to attract or encourage business activitieswithin a particular sector of the economy. The government can alsooffer non monetary incentives such as exemption from some regulationto encourage a particular line of business in the economy. Thegovernment offers incentives to business activities depending on thelevel of government (local, national or regional) and the cost of theincentive. The ultimate goal of government incentives is to induceeconomic activities which will trigger economic growth. Economicincentives increase job opportunities, government revenues andtrigger development in less developed regions. On the other hand, thegovernment can offer disincentives in a particular sector of theeconomy to discourage investment. For example, the government cancomplicate the regulatory conditions to discourage investors fromventuring into some sectors. In several countries, the governmentrequires all cigarette manufacturers to give a warning to theirconsumer, in graphics and texts, on the health risks associated withcigarette smoking. Other countries have restricted drinking hours todiscourage alcohol intake. Such regulations are can be considered tobe disincentives since they have a negative impact on the sector ofthe economy, thus discouraging investment (Mirrless, 2010).
Some of the most publishedincentives and disincentive in the modern economies are governmentpolicies that encourage individuals to start small businesses. Theyalso include government incentive to large organizations to locatetheir units of production away from the urban centers anddisincentives to those located in large urban centers. Majority ofeconomies in the modern world are faced with high rates ofunemployment. Therefore, governments have made several attempts toencourage the public to be self employed. According to Mirrless (2010p1085), there is a strong assumption “that small businesses shouldbe provided with tax incentives and reliefs”. Although someeconomists have been opposed to blanket incentives to small businessenterprises by the government, there are some rationale that supportsome of the favors. One of the basic reasoning of government supportto small business organizations is “the need to counter marketfailures” (Mirrless, 2010 p 1085). People are unwilling to ventureinto business activities due to perceived or real market failuresthat have been experienced by others. Incentives can be used as acounter measure to promote small business ventures. Governments canalso give incentives to small businesses due to “the desirabilityof countering inherent disadvantages of being small” (Mirrless,2010 p 1085). In many cases, the small business organizations enter afree market dominated by huge organizations, including multinational.Some of them are unable to compete in the market without financial ornon financial support from the government. Additionally, smallbusinesses are mainly family businesses. To ensure that they survivefamily challenges, the government may offer incentives. Supersedingthese rationales, the importance of small business organizations inthe economy can not be underestimated. They play in important role in“creating wealth, stimulating competition, and creating jobs”(Mirrless, 2010, p1085). This justifies government incentives.
However, governmentincentives are not a preserve of the small business organizations.The government is also able to influence the activities of theactivities of huge multinationals through various incentives.Majority of these incentives are aimed at promoting research anddevelopment as well as location of units of production in particularregions. According to (Mirrless, 2010 p 1122), “many governmentsoffer R &D tax incentives to firms in research intensiveindustries as part of a strategy to promote domestic innovation andcompetitiveness”. Favorable tax systems are one of the mostimportant economic incentives offered by the government tomultinationals. Governments have also been able to time reforms inthe tax systems to encourage foreign and local investments (Mirrless,2010).
Mirrlees, J. (2010).Dimensions of TaxDesign, New York,Oxford University Press Inc.
Rothbard, M. (2006). Powerand Market, Government and the Economy,Auburn, Alabama Ludwig von Mises Institute.
Seligman E.R.A. (1899). TheShifting and Incidence of Taxation,New York: Macmillan & Co.