THE IMPACT OF TAX SYSTEM ON THE ECONOMIC GROWTH OF A COUNTRY

 A Conceptual Research Paper

Author Name: Maryam Khan (Accounting & Finance)

laureatefolks@gmail.com

THE IMPACT OF TAX SYSTEM ON THE ECONOMIC GROWTH OF A COUNTRY

1. INTRODUCTION

A sound tax system is essential for the economic growth of the country. There are interconnections between these two elements based on policy makings, academicians, and regulatory circles. A large amount of tax revenues has required for running economic activities efficiently in developing countries. Tax revenues utilize both national and sub-national levels when the world has become a global village, then imports and exports increase. It introduced a Goods and Service Tax (GST) in many developing countries (Mcnabb, 2018). Developing countries are facing challenges in maintaining current tax revenues (Bird and Zolt, 2011). Tax structure and tax collection impact the economy by tax burden. The positive and negative impact of the tax system made the economic and tax growth more complex. 

In this research report, we are focusing on tax policies affecting economic development. There are two significant types of tax policies: increasing and decreasing individual income tax rates and income tax reforms (Toder and Viard, 2014). Economic growth means increasing the Gross domestic product (GDP) and Gross National Product (GNP). Income tax is a significant source of revenue generation. It also affects the distribution of after tax-system and on various economic activities (Gordon, 2016).

Undoubtedly, low tax rates show the expansion of economic development in the long-term period.  Low tax rates raise the after-tax returns that can lead to savings and investments in the country. Low rates ultimately cause substitution and income effects. Low tax rates are suitable for the established economies. Otherwise, they can cause a federal burden. Taxes are the source of Government revenue. When taxes are low, then Government has less amount to run the economic circle of the country. This thing is feasible for people but not for Government. Low tax rates can positively impact the economy as people's purchasing power becomes good, but it can reduce economic growth in the long run. So, the tax system is complex, as it involves tax changes and low tax rates. It is a perception that tax changes can increase the overall size of the economy.

In this research report, we present the various tax reforms and tax systems while affecting the country's economic growth in the eye of previous writers.

1.1 RESEARCH QUESTIONS

The researcher aims to follow the following research question

1.      What is the role of the tax system in the economic growth of a country?

2.      What are the positive and negative impacts of the tax changes on economic growth?

3.      What are the issues a country can face with tax-return policies?

1.2 RESEARCH OBJECTIVES

The current study involves the following objectives given research questions.

·         To explore the importance of tax in economic growth in the eye of current analysis and past research literature.

·         To explore the positive and negative impacts of tax policies in an economy

·         To analyze the various issues a country can, face while changing its tax policies

·         To investigate the income tax effect on individual lives

·         To examine the role of the Government in making a tax system.

·         To explore the future implications regarding tax policies in the economic growth of the country.

1.3 SIGNIFICANCE OF THE STUDY

·         The current study aims to explore the significant impact of the tax system on countries' economies. The study is essential in many ways.

·         This study may help demonstrate the unique tax policies f various countries.

·         The study may help motivate people to make investments when there are low tax rates.

·         This study may be helpful for the Federal fiscal department to acknowledge issues and crises led by the flawed tax system.

·         The study may be helpful for the reader to get aware of the importance of income tax effects in one's lifestyle.

·         The current study is unique as it shows both positive and negative impacts on the economy.

2. THE BACKGROUND AND SCOPE OF THE STUDY

While looking for the background of the study, we found that the tax system has been running from ancient eras. But now, it is developed in today's digital world. Here we are presenting an extensive literature review in the eye past research studies conducted by experienced writers.

With the Biden organization proposing many new expenses, it merits analyzing how duties impact the monetary turn of events. We directed a survey of the information in 2012, noticing that most of the examination discovered troublesome impacts. Be that as it may, various studies have been distributed from that point forward, some of which utilize further developed practical ways to decide the causal impact of charges on the monetary turn of events. This new proof, which affirms our past decisions, is examined underneath: Taxes, especially those demanded on business and individual pay, smother financial advancement.

The effect on the GDP rate by changing tax policies is hard to evaluate as various other circumstances affect the overall economic activity. Sometimes tax policy changes as a result of a change in monetary policy. It becomes a dependent variable here. When the substitution effect rises, Government increases the import and export duties. Therefore, most of the writing lately has taken on this strategy, as examined underneath (Roomer and Romer, 2010). Looking at unforeseen changes in charge strategy alluded to viewed by financial experts as "exogenous shocks."

There are other methodological issues to consider. Inability to represent different factors affecting financial development, like government consumption and money-related arrangement, may bring about an odd take on the cold, hard truth or exaggeration of the impact of duties on development. Some assessment changes, for example, partnership charge increments, may have more since quite a while ago run impacts than short-run impacts, and an examination with a confined time series may neglect this impact. At last, charge changes have many moving parts: Certain expenses might be raise, while others might diminish. Therefore, it may be hard to recognize a few changes as net duty increments or cuts, prompting a wrong view of how assessments influence development.

We look at articles distributed in significant financial aspects diaries and National Bureau of Economic Research (NBER) working papers during the most recent couple of years, considering both homegrown and unfamiliar proof. This review looks at a broad scope of expenses, like pay, utilization, and company tax collection. Each of the seven articles assessed here finds that tax breaks support development, while a few papers underline that this effect's size changes depending on which charges are brought down, for whom, and when.

The specialist assessed the impacts of nominal duty rates on individual pay utilizing time-series information from 1946 to 2012. They found that a negligible rate decrease brought about gains in genuine GDP just as diminishes in joblessness. The GDP rate has increased by 0.78% due to a change in taxation policy. It shows that the positive GDP upgrades found by the creators are the consequence of changes in motivators instead of an expansion in total interest through the utilization channel. Tax breaks for the top 1% affect other pay classifications, which is reliable with a stock side account of how lower top minimal rates might raise income for different gatherings after some time Tax breaks for the top 1%, then again, advance disparity (Mertens and Olea, 2018).

From 1950 to 2011, a specialist examines the impact of government taxation rates on financial development and work supply across various pay gatherings and states. He finds that tax reductions affect economic development two years after the approach change. However, tax breaks for low-and moderate-pay citizens significantly affect development than tax breaks for top-level salary citizens. The report indicates that a 1% decrease in state GDP charges for the least fortunate 90% of pay raises state GDP by 6.6 percent. Taking a gander at work supply impacts, he finds that a 1% decrease in state GDP charge supports workforce cooperation for the least fortunate 90% of profit by 3.5 rate focuses and hours worked by 2%. Rather than the discoveries of Mertens and Olea (2018), he investigates the workforce investment, duty hours, incentives, and overall GDP rate resulting from a change in tax policy (Zidar, 2019).

This end might persuade some to think that Zidar recognizes "Keynesian" or total interest effects of expense increments. Nonetheless, the examination exhibits that tax reduction altogether affects genuine profit too. As per Zidar, "the increment in genuine wages infers that supply-side responses to burden changes are significant and may offset request side reactions for the most minimal 90%." Furthermore, some might guarantee that this examination shows that tax reductions for big-league salary people have no impact on development. Be that as it may, this examination thinks about the short-run effects of duty changes on GDP and doesn't address the since a long time ago run impacts of expense strategy on development, human resources, or advancement. Regardless, the examination presents persuading proof that tax breaks impact development, which is reliable with the neoclassical financial hypothesis.

A specialist analyzed 250 state company charge changes between 1970 and 2010 to decide their effect on work and pay. By looking at contiguous districts across states, the creators can separate the impacts of organization charge expansions comparable to different strategies that might affect economic development. They find that bringing down legal enterprise charge rates by one rate guide leads to a 0.2 percent ascend in business and a 0.3 percent increase in profit. They find that assessment climbs are almost consistently negative, though tax breaks seem to have the best specific impact during downturns. Similar to a few of the different examinations portrayed here, the article centers around short-run effects, even though almost certainly, these beneficial impacts might grow throughout a more drawn-out time skyline (Ljungvist and Smolyansky, 2018).

Experts research the impacts of significant worth added charges (VAT) on monetary improvement utilizing information from 51 countries from 1970 to 2014. They find that the effect of charges on development is exceptionally nonlinear. The results are nil for low rates with minor changes; however, the monetary damage increments with a more special gauge charge rate and more incredible rate changes. Subsequently, ascends in VAT in nations with high VAT rates, like many industrialized Europe, will significantly affect GDP than climbs in low VAT countries. These non-linearities propose that Laffer bend impacts are enormous: Further climbs at some duty rates will decrease Government charge assortments. The creators gauge an expense multiplier of - 3.6 for European industrialized countries two years following a duty change, suggesting that tax breaks significantly support monetary movement in these nations (Gunter et al., 2019).

From 1973 through 2009, scientists analyzed the impacts of individual pay, business, and utilization charges in the United Kingdom. They find that annual tax breaks, characterized in their review as unique and enterprise pay, affect GDP, private utilization, and speculation. A 1% decrease in the average personal duty rate helps GDP by 0.78 percent. The effects of utilization charge decrease are humble and didn't make genuinely huge impacts. However, the examination reasons moving from pay to a utilization charge base beneficially affect development. Utilization charges are ordinarily seen as less distortive than different sorts of tax assessment since they have little impact on the motivations to work and contribute that are basic for keeping up with since quite a while ago run financial development (Nguyen et al. 2021).

Investigators look at the U.K.'s interwar period, 1918-1939, a period of high obligation and low loan fees, to all the more likely comprehend the impact of duties on the monetary turn of events. At that point, the British expense framework was, for the most part, included extract charges on liquor, tobacco, and engine vehicles, with pay and business profit burdened less significantly. Since this period originates before the approach of Keynesian macroeconomic hypothesis, charge measures were commonly not expected to be countercyclical, but instead to adjust the spending plan, diminish imbalance, or lift efficiency. The creators find that a one-rate point quit raising in government expenditures as an extent of GDP expands GDP by 0.5 to 1%, ascending to 2% following one year. While the British economy a century prior contrasted extraordinarily from current economies, this review gives persuading proof regarding how assessments influence development in high obligation and low loan cost circumstances (Cloyne et al., 2018).

Scientists are leading a meta-examination of the effect of assessments on development in OECD countries. Their example comprises 979 evaluations drawn from 49 explorations. Not at all like different examinations tended to in this survey, this one considers both the effects of tax collection and consumption on development. The creator's sort strategy changes into three kinds: charge negative monetary arrangements, charge positive financial system, and assessment questionable economic approaches. Assessment climbs to help in effective ventures or expansions in distortionary charges matched with a drop in non-distortionary orders are instances of expense negative financial strategies. Estimate rises to fund helpful speculation, decreases in distortionary burdening compared with expansions in non-distortionary tax collection, or duty increments to bring down the shortfall are instances of expense positive financial strategies. Expense uncertain economic approaches are ones in which the absolute monetary effect is obscure. Utilizing these classes, the creators find that a 10% decrease in charges from an expense negative economic bundle supports GDP development by 0.2 percent. The equivalent estimated tax reduction for payment well disposed monetary measures diminishes GDP development by 0.2 rate points (Alinaghi and Reed, 2021).

 

 

 

 

 

 

 

 

 

 

Figure 1: Impact of tax system in economic growth

2.1 THEORETICAL FRAMEWORK

Undoubtedly, changes in tax rates may affect the overall economic activities. So, we are exploring the effects that come in lowering and increasing income tax rates.

2.1.1 Reduction in the Tax rate

Reducing Income tax rates may affect individuals and corporate. Tax breaks impact the development of the economy since they increment the after-tax reduction for working, saving, and contributing. Through replacement impacts, these more substantial after-tax reductions drive expanded work exertion, saving, and venture. One more advantage of unadulterated rate decrease is that they lessen the benefit of existing expense mutilations and incite productivity. Further developing change in the blend of monetary movement away from right now charge supported areas like wellbeing and lodging (in any event, when the volume of financial action stays steady). Be that as it may, an unadulterated rate may have a positive pay (or abundance) impact, decreasing the need to work, save, and contribute (Arnold et al., 2011). A general decrease in personal assessment rates, for instance, consolidates these advantages. It raises the minor re-visitation of business, boosting work supply using the replacement impact.

2.1.3 Financing

Tax policies affect not only economic development but also the decisions of government spending. The fundamental approach is to get maximum tax revenue so that Government can bear its expenditures. The Government uses many high budgets with tax revenues and debts paid from this revenue. When the Government's financial needs are fulfilled, subsidizing duties cannot create more deficits. Decreasing tax rates rely on the Government's current debt (He et al., 2011). In the past, the tax reduction depended on the capital reserves of the country. Tax rates increase when a government takes more loans for the development of the country. An increase in debts causes an increase in tax rates. These changes may increase or decrease the public savings and capital reserves in the country. In short, when the Government raises financing through loans and debts, tax rates rise, and there is a lack of economic development.

2.1.4 Other Governmental Organizations

Other legislative associations, like the national bank, state governments, and foreign governments, may react to bureaucratic expense decrease. For instance, the Joint Committee on Taxation (2014) examines what elective Federal Reserve Board arrangements may mean for the effect of Representative Camp's duty change thoughts on the monetary turn of events. Unfamiliar nations' potential reactions are much of the time ignored. Tax breaks in the United States, for instance, that advance capital inflows from outside, may move different countries to bring down their assessments to hold capital or draw in U.S. reserves. On the off chance that other countries react, the net impact of personal tax reductions on development will be lower than it would be something else.

3. EMPIRICAL ANALYSIS

"Financial development" can apply to something like three different thoughts. The most basic definition is that economic development is the consistent state pace of development that emerges from an organic market financial model after some time. This thought is excessively restricted for our motivations since it ignores any development during the (possibly extended) progress between a consistent state under one assessment system and the constant state to which the economy joins following an adjustment of expense strategy. The amplest definition is any adjustment of the measure of monetary action all through any timeframe. This idea supports appraisals of the capacity of duty changes in adjustment strategy to streamline financial varieties at business cycle frequencies, certainly if not plainly. Given our focus on the stock side of the economy, this idea is excessively expansive. The measure of financial action might develop throughout brief timeframes as, for instance, tax breaks to adjust actual and potential GDP instead of raising potential GDP.

Another idea, middle of the road between the past two, considers any adjustment of financial movement across time spans longer than the business cycle. It may be something that invigorates the economy on a one-time, long-lasting premise, something that changes the economy's consistent state development rate, or something that does both. For an assortment of reasons, restricting thoughtfulness regarding longer ranges of time is adequate. First of all, investigating more extended periods adjust the impact of expense strategy throughout the business cycle. It portrayed re-enactment examinations underneath; tax breaks might have a positive short-run impact on monetary movement. However, a negative since a long time ago run impact when higher loan costs from the subsequent shortages muffle other financial activities. Third, focusing on a more drawn-out period guarantees that the full effect of duty changes consider.  A starter takes a gander at verifiable information from the United States. The 11 cross-country insights on development rate incongruities between countries show no generous connection between financial development and personal assessment strategy.

3.1 Variations in taxation and growth

The utilization of the GRD, which gives a significantly more broad and solid type of revenue information than some other single source, is one of the review's primary forward leaps, especially for non-industrial countries. It is refined by systematically consolidating data from various global sources, including the IMF's GFS and OECD Revenue Statistics, just as information from the IMF's Article IV Staff Reports. The GRD likewise exhorts clients when considering perhaps befuddling or off base, determined to try not to delude concentrate on outcomes. It includes 6390 perceptions for 196 countries from 1980 to 2012/2013. However, for various reasons, the econometric investigation utilizes a more modest example of this information. An imbalanced time series for every country included is needed for the PMG assessor to unite. The model is restricted to countries with 20 years of continuous information, guaranteeing that the t measurement is adequately long. Last, perceptions that have been set apart as conceivably unsafe likewise dispensed.

At last, the investigation is restricting by the absence of extra factors. The previous example for the econometric review incorporates 2657 perceptions from 100 distinct countries.

4. CONCLUSION

For economic development, a fair and justified tax system is essential. Economies can destroy if they lack good monetary and fiscal policies. Tax is an excellent source of generating revenues and Government-run the country's expenses from this revenue. With the Globalization of this world, many countries have become open trade zone. It led to import and export duties. These duties increase with time as the trade has boosted. A government gets excellent benefits while applying import and export duties. It is on one side of the picture.

The other side of the picture is by increasing tax rates, poverty rises, especially in developing counties. Countries at the breakeven point of the poverty line and below the poverty line are going through the worst economic conditions while increasing tax rates. So, to avoid these crises, base tax is significant. The base tax rate should be keeping that level where everyone can pay it off. Economies will develop if the base tax rates are justified.

Similarly, if the tax rates are low, then consumers show the substitution of the income effect. The people have more purchasing power. They can save or invest the money. If the investments increase, then it will increase the overall GDP of the country. So, it will show a positive impact on the economy. So, a balanced tax system can keep the economy at a boom period. For this purpose, Government has too fiscal solid and Monetary policies.

5. FUTURE RECOMMENDATION

Here are a few recommendations for future implications and researcher.

·         The tax system should be according to the poor in the country

·         The Government should have a strong team for the collection of taxes. If someone is not paying tax on time, penalties and punishments should impose to maintain discipline in the country. 

·         Government should exempt the poor from tax.

·         The tax policies should review quarterly as per the external factors.

·         Taxes should be exempt from the necessary items like milk, sugar floor, etc.

·         Taxes should be higher for luxury items so that a good amount of revenue can generate. 

·         Future Researchers should investigate the best tax system countries and explore their success stories so that others can benefit from them.

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