Question

What are the objectives of a tax system? What makes a tax system complicated? Describe, in sufficient detail, the following major tax reform plans: a. Flat Tax b. Fair Tax c. Competitive Tax (suggested by Michael Graetz) Discuss the pros and cons of each of these plans. List, in bullet-point form, at least 5 pros and 5 cons for each plan.

Answer 1

Objectives of a tax system:

(1) Major source of Revenue: Tax system is major source of Revenue for Goverment to meet huge public expenditures. Most governmental activities are financed by taxation.

(2) Economic Development: One of the important objectives of taxation is economic development. For economic development, government invests huge amount on growth of capital formation. Increase in Capital formation leads to Economic Development.

(3) Increase in Employment: Since the level of employment depends on effective demand. To increase employment, a country must cut down the rate of taxes. Consequently, disposable income will rise and, hence demand for goods and services will rise. increased demand will encourage investment leading to a rise in income and employment.

(4) Control of boom and depression: During depression, taxes are cut down which increase the disposable income of the consumer while during boom, taxes are increased so that consumer make the demand less than before and cyclical fluctuations are tamed.

(5) Price Stability: Taxes are regarded as an effective means of controlling inflation, By raising the rate of direct taxes, private spending can be controlled. The demand pressure on the commodity market is reduced.

What makes a tax system complicated?

In the currrent tax law numerous provisions and tax bills are included which make the tax system complicated. Tax incentives are often designed in complex ways to limit the revenue losses or benefits to high-income taxpayers or to prevent their use by unintended beneficiaries.

Factors which makes the tax system complicated:

(i) Numerous source of income:

Income from salary, income from house property, Business income, Income from capital gain, income from other sources

(ii) Creating Incentives:

Tax law gives incentives to their tax payer to encourage them.

Incentive to workers to save for retirement.

Incentive to business owners to invest in productive industries.

incentive to investors to put money into underdeveloped communities.

(iii) To prevent violation of the rules:

Tax system also prevent the taxpayers to violate the rules save more money.

Flat Tax:

A flat tax is a system where everyone pays the same tax rate, regardless of their income.

Pros:

• Increase investments and to generate economic growth and employment
• Easy to understand
• Eliminate additional taxes.
• simplify the tax filing process
• Easy to calculate

Cons:

• low-income earners have to pay the same tax as high income earners
• Loss of incentives
• No tax deductions benefits
• discourage charity
• Lower tax receipt

Fair tax:

The Fair tax Plan is a sales tax proposal to replace the current U.S. income tax structure. It abolishes all federal personal and corporate income taxes. The plan replaces them with a federal retail sales tax of 23% to administered by state sales tax authorities.

Pros:

• Eliminates annual tax preparation headache and costs.
• Eliminates IRS
• Boosts income and possibly consumer spending
• Reduction in Government Spending
• Increase GDP, jobs, productivity and wages.

Cons:

• Unfair to seniors who have already paid income taxes.
• Needs a new agency to inforce it.
• Sales tax rate would be prohibitively high ot replace lost revene.
• Become very expensive to monitor and enforce.
• Increasing Potential for tax evasion

Competitive Tax (suggested by Michael Graetz)

Columnia University law Professor Michael Graetz introduced "Competitive Tax Plan", which is based on comsumption than income. It is a progressive consumption tax, a so called value added tax. VAT, also known as Goods and Services tax(GST), is a consumption tax that is assessed on products at each stage of the production process.

Pros:

• Constant revenue income
• easy to manage than other indirect tax
• Reduce payroll taxes
• reduce income tax burdon
• Reduce corporate tax

Cons:

• Increase inflation
• Discourage consumption
• regressive in nature
• Based on paperwork
• must report with accuracy