IMPORTANCE OF TAX & ECONMIC GROWTH

ASSIGNMENT IMPORTANCE OF TAX IN ECONOMIC GROWTH

Submitted To: SIR SAJJAD ARIF Course: TAXATION

Submitted By: ABDUL WAHAB REG # 12927 DATED: 14TH DEC, 2012

IMPORTANCE OF TAX & ECONMIC GROWTH TAX

Tax is a contribution exacted by the state. It is a non penal but compulsory and unrequited transfer of resources from the private to the public sector, levied on the basis of predetermined criteria. The classical economic were in view that the only objective of taxation was to raise government revenue. But with the changes in circumstances and ideologies, the aim of taxes has also been changed. These days apart from the object of raising the public revenue, taxes is levied to affect consumption, production and distribution with a view to ensuring the social welfare through the economic development of a country. For economic development of a country, tax can be used as an important tool in the following manner: 1. Optimum Allocation Of Available Resources: Taxis the most important source of public revenue. The imposition of tax leads to diversion of resources from the taxed to the non-taxed sector. The revenue is allocated on various productive sectors in the country with a view to increasing the overall growth of the country. Tax revenues may be used to encourage development activities in the less developments areas of the country where normal investors are not willing to invest. 2. Raising government revenue: In modern times, the aim of public finance is not merely to raise sufficient financial resources for meeting administrative expense, for maintenance of low and order and to protect the country from foreign aggression. Now the main object is to ensure the social welfare. The increase in the collection of tax increases the government revenue. It is safer for the government to avoid borrowings by increasing tax revenue. 3. Encouraging savings and investment: Since developing countries has mixed economy, care has also to be taken to promote capital formation and investment both in the private and public sectors. Taxation policy is to be directed to raising the ratio of savings to national income. 4. Reduction of inequalities in income and wealth: Through reducing inequalities in income and wealth by using a efficient tax system, government can encourage people to save and invest in productive sectors.

IMPORTANCE OF TAX & ECONMIC GROWTH

5. Acceleration of Economic Growth: Tax policy may be used to handle critical economic situation like depression and inflation. In depression, tax is set to increase the consumption and reduce the savings to increase the aggregate demand and vice verse. Thus the tax policy may be used to strengthen incentives to savings and investment. 6. Price Stability: In under developed countries, there is another role to maintain price stability to ensure growth with stability. 7. Control mechanism: Tax policy is also used as a control mechanism to check inflation, consumption of liquor and luxury goods and to protect the local poor industries from the uneven competition. Taxation is the only effective weapon by which private consumption can be curbed and thus resources transferred to the state. Thus the economy can ensure sustainable development. Thus it can be said that the economic development of a country depends various reasons one of them are on the presence of an effective and efficient taxation policy.

WHY TAXES AFFECT ECONOMIC GROWTH

Tax policy stands at the center of effort to get public policy right for economic growth. Tax policy mirrors view of the role of government in everyday life and parallels the level of spending and the diversion of resources to the state. It reflects as well opinions about the social worth of achievement and financial caution and shapes our practice of the principle of equality before the law and equal access to due process. We know from our study of over 130 other countries that those with low tax rates on labor and capital relative to the average have adopted other public policies that promote growth: free trade, minimal restrictions on the import and export of capital and labor, rule of law, stable money, and light regulations on the use of one's private property in production. Countries with below-average tax rates on labor and capital have long-term growth rates that are about 0.6 of a percentage point higher than those countries at or above the average. An expanding economy generally means that new products and services are being produced that improve the well-being of people who participate in that economy. Economic growth rates that exceed the rate of population growth imply economic change that is making people better off. Thus, the individual decision to do more with his or her labor or capital is crucial to change. If contributing an additional hour of labor or dollar of capital means having to pay more taxes because that additional unit is taxed at a higher rate, then staying put may make good sense. Just reducing the total amount of taxes a person or business pays through deductions or credits may lower their overall costs. It can leave a person in the "stay-put" position, however, if working an additional hour still means that income from that hour will be taxed at a

IMPORTANCE OF TAX & ECONMIC GROWTH

higher rate. In tax economics, it is the marginal unit or the next piece of the decision puzzle that really matters. The importance of tax policy to economic growth is illustrated by exploring obvious tax effects in the six characteristics of growing economies that new growth theorists have identified. Accumulating capital. Tax policy can affect the stock of physical capital directly. If taxes on the earnings of capital (interest, dividends, capital rents) rise too high, then the owners of capital will charge higher prices for the use of their capital. The usual result from an increase in the price of capital is greater use of human labor to do the "work" that machines previously performed or refusal by management to adopt the latest labor-saving technologies. In any event, the productivity of people falls, which reduces potential well-being and the rate of economic growth.

Keeping government small. The sole purpose of a tax system should be to produce necessary income for government in as economically and socially neutral a fashion as possible. When the tax system is used as a tool for producing certain economic and social outcomes (such as universal home ownership, inexpensive access to education, and redistribution of income to needy families) it becomes, perhaps by accident, the essential partner in expanding the scope and size of government. History never has seen a tax system employed for "purposes of the state" that did not engender a large and expensive bureaucracy. When government grows relative to the economy and the population, it diverts scarce resources from those activities in the private sector that could improve everyone's well-being. The growth of the economy inevitably falls below its potential. Opening the economy to foreign trade and investment. Tariffs and restrictions on trade and investment are, of course, the oldest forms of taxation known to government. Any foreignproduced product that must pay an entry fee in order to compete for sales in the Pakistan starts from a disadvantaged position. If such a product is superior to one produced in the Pakistan, then Pakistani consumers are directly harmed by having to pay a higher-than-normal price for a superior product. If such border taxes and other trade restrictions become too high, they can shut off valuable investment and product sales in the United States. When investment falls and Americans lose access to new and superior technology, the economy suffers, and the growth rate falls below potential. Respecting property rights and the rule of law. History is full of taxing authorities that undermined the rule of law in their zeal for revenues. History also is filled with evidence that the rule of law and respect for property rights may be the most important prerequisites for economic growth. Certainly, when unexpected political change in a country leads to new rules and violations of property rights, economic activity quickly falters. Severely restricting the taxing authority's power over property and information about income is one of the most proved and certain ways of advancing economic growth. Not burdening the productive sector with unnecessary government regulations and controls. Another tax often overlooked is any regulation that adds to the cost of producing a good or service or prohibits a certain economic practice or behavior. Behavioral taxes actually may be more influential in shaping many decisions at the margin than income taxes. Certainly, any foreign

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company thinking about opening a factory in the United States must carefully assess the additional costs of operation that stem directly from our country's clean air and water regulations. Even though many Americans would not want to live without such regulations, they should recognize that these taxes on property use and economic behavior directly reduce economic activity and the rate of economic growth. To the extent that behavioral taxes reduce economic growth, they reduce economic well-being. Investing in "human capital." Clearly, any country that has instituted low-tax and -regulation policies, the rule of law, free trade, and stable money will benefit from a more educated workforce. Too often, countries (including the United States) assume that universal education will lead to economic prosperity and that nothing need be done about the rights of people to keep the fruits of their labor, to open new businesses, to immigrate freely, or to enjoy objective laws that are evenly administered. Of course, recent history is replete with examples of huge investments made in educating poor people who remain stubbornly poor no matter how literate they become because they are not permitted to keep most of their income or build family wealth. Education really only adds to economic growth in a society in which the taxes levied on an individual's productive use of education are low and fair; otherwise, universal education is an enormous waste of a country's resources.

INCOME INEQUALITY AND GROWTH: THE ROLE OF TAXES AND TRANSFERS

Inequality of income before taxes and transfers is mainly driven by the dispersion of labor income and the prevalence of part-time employment and inactivity. Despite their wider dispersion self-employment and capital income play a smaller role. Tax and transfer systems reduce overall income inequality in all countries. On average across the OECD, three quarters of the reduction in inequality is due to transfers, the rest to direct household taxation. In some countries, cash transfers are small in size but highly targeted on those in need. In others, large transfers redistribute income mainly over the life-cycle rather than across individuals. The personal income tax tends to be progressive, while consumption taxes and real estate taxes often absorb a larger share of the current income of the less well-off. Some reforms of tax and transfer systems entail a double dividend in terms of reducing inequality and raising GDP per capita. In particular, reducing tax expenditures, which mostly benefit the well-off, contributes to equity objectives while also allowing for a growthfriendly cut in marginal tax rates. Other reforms may entail trade-offs between these two policy objectives. Shifting the tax mix to less-distorting taxes in particular away from labor towards consumption would improve incentives to work and save, but raise inequality at least at a given point in time.

IMPORTANCE OF TAX & ECONMIC GROWTH Pakistans Roller-Coaster Economy:Tax Evasion Stifles Growth
Over the last sixty years, Pakistans economy has seen severe ups and downs. Once considered a model for other developing nations, Pakistan has been unable to sustain solid growth. Furthermore, a third of its population now lives below the poverty line, and its literacy rate is abysmally low. Pakistans economic instability stems in large part from low government revenue resulting from the elites use of tax evasion, loopholes, and exemptions. Fewer than three million of Pakistans 175 million citizens pay any income taxes, and the countrys tax-to-GDP ratio is only 9 percent. Tax evasion means fewer resources are available for essential social services. Pakistan spends too much on defense and too little on development: It has spent twice as much on defense during peacetime as it has on education and health combined. The government knows how to increase its revenue through tax reform, but the rich and powerful have resisted such measures for fear of lowering their own incomes. Without sufficient revenue the government will continue to be burdened with an unsustainable debt. It needs to end tax exemptions for the wealthy and develop broader, long-term economic plans for sustainable growth. In the past, the United States and other Western nations have come to Pakistans rescue by paying off debts and funding development initiatives. Pakistans elite has no reason to support reform as long as these bailouts come with no conditions attached.

A TIME LINE
1947 Pakistan becomes independent nation-state 19581968 Ruled by General Ayub Khan; known as the Decade of Development; high growth rates; high income and regional inequality 1971 Growth is relatively low; nationalization of private businesses under Zulfikar Ali Bhutto; public sectorled development the norm 19771988 High growth rates under General Muhammad Zia ul-Haq 19881999 Numerous governments; debt crisis; high dependence on international loans; economic performance nosedives 19992008 Pakistan ruled by its third military dictator, General Pervez Musharraf; economy grows due to debt restructuring and large doses of foreign aid and assistance following the 9/11 terrorist attacks Dec. 2007 Assassination of former prime minister Benazir Bhutto Feb. 2008 Prime Minister Yousuf Raza Gillani elected to head a coalition government Sept. 2008 President Asif Ali Zardari replaces General Musharraf Nov. 2008 IMF lends Pakistan $7.6 billion; later increases loan amount to $11.2 billion 20082009 Growth rate of only 1.2%; inflation rate of 21% 20092010 Growth rate around 4% July 2010 Total foreign debt rose to $55 billion

IMPORTANCE OF TAX & ECONMIC GROWTH

Policy Recommendations Pakistani policy makers and politicians need to understand that they cannot go on living on borrowed money forever. They must build a partisan consensus to tax the rich and the elite (mostly themselves) if they wish to bring Pakistan up to speed with other developing countries in the region. They must eliminate unjustifiable tax exemptions and preferences given to sectors or individuals, and institute in its place a broader policy that taxes earnings and wealth, not activities. Pakistan must improve documentation o the economy in order to better estimate taxable income and increase government revenue. Pakistans leadership needs to rise above party politics and, with the advice and consent of a supportive opposition, implement a broader economic framework. Donor countries need to recognize that they have bailed out Pakistan too often. They should instead pursue a do more approach, emphasizing tax and economic policies that can harness Pakistans huge underreported revenue potential.

CONCLUSIONS
Taxes matter. Indeed, they matter a great deal. Low taxes mean less government spending and more resources stay with private persons and companies. This leads to greater savings, investment and work. On average, the market disciplined private sector makes more productive use of resources than the politically driven non-market allocations I the public sector. To be sure, some taxes are worse than others from the standpoint o increasing economic prosperity. Income taxes are particularly harmful, especially those levied on individuals. Sales taxes are less harmful, and property taxes are somewhere in between. The use of the benefit principle of public finance seems to make economic sense where possible, as fees and user charges do not seem to have the adverse growth effects of taxes. Federal grants to state do not directly seem to promote economic growth.

REFRENCES:
TAXES AND ECONOMIC GROWTH-By Richard Vedder-Ohio University-September 2001 www.OECD.com Pakistans Roller-Coaster Economy:Tax Evasion Stifles Growth by S . A k b a r Z a i d i Visiting Scholar, South Asia Program http://ideas.repec.org/p/oec/ecoaaa/713-en.html