Tax policy

Choice by a government as to what taxes to levy, in what amounts, and on whom

Tax policy refers to the guidelines and principles established by a government for the imposition and collection of taxes. It encompasses both microeconomic and macroeconomic aspects, with the former focusing on issues of fairness and efficiency in tax collection, and the latter focusing on the overall quantity of taxes to be collected and its impact on economic activity. The tax framework of a country is considered a crucial instrument for influencing the country's economy. Tax policies have significant implications for specific groups within an economy, such as households, firms, and banks. These policies are often intended to promote economic growth; however, there is significant debate among economists about the most effective ways to achieve this. Taxation is both a political and economic issue, with political leaders often using tax policy to advance their agendas through various tax reforms, such as changes to tax rates, definitions of taxable income, and the creation of new taxes. Specific groups, such as small business owners, farmers, and retired individuals, can often exert political pressure to reduce their share of the tax burden. The tax code is often complex and includes rules that benefit certain groups of taxpayers while shifting more of the burden to others.

Direct administrative costs are on the government side (the burden is borne by the government). "It is not immediately obvious, exactly, which activities should be attributed to the operation of the system" (p. 19). There is no consensus about what should and should not be included under the definition of compliance costs, although one distinction usually made is between gross versus net compliance costs. The difference between the two is made up by any financial or managerial benefit derived by the taxpayer from tax compliance. However, there is a possibility to define some indisputable examples of costs, that are directly connected to the compliance of individual taxpayers. These examples include the costs of labor and time required for the completion of tax activities, such as acquiring the necessary knowledge to operate within the tax system properly, or compiling and creating all documents needed. More examples include the cost of purchasing professional assistance for the completion of tax activities, or other expenses connected to tax activities, such as purchasing software and hardware. Other types of compliance costs, such as the negative psychological effects on taxpayers as a result of the attempts to comply with the current tax policy, or many types of social costs, are very intangible, and it is, therefore, hard to quantify them, even though the effect of their existence is visible, especially for individuals and small businesses.

Efficiency for economists is equal to the concept of Pareto efficiency. Pareto efficiency means the situation of resource allocation where the concept of 'net' is dominant. In other word, basically we need to make someone worse in order to make others better under this efficiency. To seek for the efficiency, it is necessary to build the decentralized market mechanism. And to build that mechanism, tax system is often seen as an obstacle. Here, we need to think about the balance between efficiency and equity. And the best point of this balance is called 'Pareto improvement'. This is the ideal answer to reply for the question of which policies should be implemented.

The choices or decision of government are one of social choices. Social choice consists of two elements: Individual level and societal level. For the individual level, each individual builds their preference and has their utility following the budget's constraint. This can form an indifference curve. And we can say that the points which are on this curve are matched to pareto efficiency. In the society's level, the curve are created by seeing the participants as group A and group B. Here, the curve are an inversely proportional relationship which is a very common style in the Pareto efficiency's curve. In this curve, when group A's utility will get down, group B's utility will get increased. (There are other curves in other ways: Utilitarian way and Rawlsian way). When attempting to implement economic policies and projects, the measurement of the net benefits of different groups are needed and to consider that the project/policy is the Pareto improvement. Under social choice if the project/policy has net positive gains and reduces measured inequality, it should be taken. If net positivity can not be clearly determined, other factors are utilised: The compensation principle, the inverse proportional of measures of efficiency and equality, and the weighted benefits approach. The inverse proportional of measures of efficiency and equality is the judgement based on the contemplation of efficiency and equality. The weighted benefits approach is focused on the total amount of utility. The compensation principle is based on the willingness to pay the tax. If people are motivated to pay, there is a growth in consumer surplus. In this principle, when the willingness to pay is more than the cost to do so (Including if there is a cost imbalance for individuals) the projects/policies should be taken. The compensation principle can overcome the difficulty of taxation due to the intervening efficiency.

the EU Commission stated the belief that "there is no need for an across the board harmonization of Member States' tax systems.". Member states are to take full control of which tax system they want to impose, as long as they respect the rules of the EU. There is a possibility for tax field action of the EU under the principles of subsidiarity and proportionality,

There are several challenges that tax policymakers in developing countries have to face and that make it difficult for each of these developing countries to introduce effective and equitable tax systems, tackle inequality and corruption or increase their development level. As a result of this, developing countries often use tax policies that are not very effective in terms of generating tax revenue, therefore not allocating the country the funds needed for improvement.

As many people in developing countries are often paid wages based on the time they spend at work (volatile value), and many are paid in cash which lowers the government's ability to track such money flows, it is difficult to keep record of any reliable data on income and wealth distribution in the country. This leads to a situation in which the policymakers are unable to create statistic or models that would allow them to propose changes to the current tax system (mainly income taxes in this case) in the country, that would improve the situation (mainly the efficiency vs. equity trade off).

Similarly to the problem regarding unclear incomes, a big part of the spending in developing countries is done in such a way that does not lead to extensive spending reports being supplies to the government. This lack of information is supported by the fact that just like in the case of incomes, most spending is done in cash which is, again, more difficult to keep record of. In this situation, policymakers are deprived of the ability to analyse spending statistics in their country and thus they are not able to produce changes to the tax system (mainly the sales taxes) in their country.

"With regard to taxes on imports, lowering these taxes will lead to more competition from foreign enterprises. While reducing protection of domestic industries from this foreign competition is an inevitable consequence, or even the objective, of a trade liberalization program, reduced budgetary revenue would be an unwelcome by product of the program."

Despite the problems in keeping track of many economic activities in developing countries, naturally, various taxes are in effect in these countries. These generate revenue but there are certain limitations to these taxes which make them not as effective as they could be.

The personal income tax in developing countries commonly have some rate of progressivity, meaning grouping individuals into various groups based on their income and then imposing different rates of the personal income tax on each group. The limitations which often make this kind of tax ineffective in developing countries are several various exemptions in the parts of individual's income that are taxable as well as setting off the borders between different tax brackets. These make it often more favourable for an individual to establish a business and therefore pay (lower) corporate income tax rather than personal income tax. But even without this, reaching the highest tax bracket (with the highest marginal tax rate) as an individual often requires incomes so high that only a small number of people in the country reach it.

Similarly to the case of the personal income tax, there are various rates of the corporate income tax based mainly on the sector that the company generates revenue in. This allows the corporations to take actions which allow them to pay lower taxes and effectively practice tax avoidance.

As much as the VAT is an effective tool to generate revenue for the government, there are some setbacks to the implementation of the VAT in developing countries. One is that there are certain goods and services which are not included in the VAT list and therefore "reduce the benefits from introducing the VAT in the first place."