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Economics of Taxation

Dr.Dadanee Vuthipadadorn

Tax Economist, Expert LevelRevenue Department

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Topics

Public Finance Budget Structure of Thailand Tax Policy Tax system and structure

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What is Public Finance? The study of how governments collect and spend money and

real resources How do governments collect/spend money? Positive analysis How should governments collect/spend money? Normative

analysis We are studying public finance in a market economy

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What is Public Finance?

Public finance is about the taxing and spending activities of thegovernment.

Scope of public finance unclear government has role in manyactivities, but focus will be on taxes and spending.

However, according to Richard A. Musgrave and Peggy B.Musgrave:

Public finance involves the role of government in 4 mainareas

4

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Richard A. Musgrave & Peggy B. Musgrave

5

1

(Allocation Function)

2

(Distribution Function)

3

(Stabilization and Growth Function)

4

(Coordination of Budget Function)

Demand for goods and servicesof the people :

Efficiency in the production of

goods and services of government

and private sectors as well as

trend in production capacity

extension:

Evaluation of social welfare

allocation:

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6

1


2(Distribution

Function)

3

(Stabilization and GrowthFunction)

4

(Coordination of BudgetFunction)

Equal& thorough distribution

of goods and services

Fare distribution of income

and wealth

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7

1


2(Distribution

Function)

3


4


Encourage and support the

economic stability and social

peace

Maintain the employment

rate at the stable level

Achieve the stability of price

and Thai currency

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8

1


2(Distribution

Function)

3


4


Coordinate the conflict in the

policy goals

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Fiscal policy

Role of Government in the Economy

Fiscal Tools Government expenditure Tax Collection Government debt

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Role of Government in the Economy

Role of Government in the Economy Allocation of resource Distribution of income Economic growth Economic stability (Internal stability & External stability ) Provision of Public goods Encourage competitive economic environment Intervention (i.e, in case of Externality and National

Monopoly)

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Fiscal Policy :changes in government

spending (G) or taxes (T) toalter aggregate demand andstabilize the economy

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Fiscal tools

Expenditure side Government expenditure (G) Government Transfer Payment (R)

Income Side Tax collection (T)

Public Debt

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$6

$6.1

$6.2

AS

0

150

155

Naturalrate

AD1

AD2

Real GDP

P r i c e

L e v e

l

E2 XE1

155

Government Spending to Combat aRecession

Expansionary

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$6

$6.1

AS

0

155

160

Natural rate AD 1

AD 2

Real GDP

E2

E1

Using Fiscal Policy toCombat Inflation

P r i c e

L e v e

l

Contractionary

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Budget surplus governmentrevenues exceed governmentexpenditures in a given period

Budget deficit governmentexpenditures exceed governmentrevenues in a given period

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Fiscal Policy Multipliers

Spending multiplier

Tax multiplier

Balanced budget multiplier

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Multiplier effect

Because of multiplier effect $1 of government purchases

Can generate > $1 of aggregate demand $1 of consumption, investment, or net exports

Can generate > $1 of aggregate demand

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Spending multiplier :change in aggregate demandresulting from a unit change ingovernment spending

e.g.: if spending multiplier = 4, G=$50Then AD=4 x $50 = $200

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Tax multiplier: change inaggregate demand resultingfrom an unit change in tax

(more tax, less C+I, less AD)

e.g.: if tax multiplier = -3, T=$50Then AD=-3 x $50 = -$150

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Marginal Propensity to Consume

MPC = Change in Cspending

Change in incomee.g.: if MPC = 0.75, Y=$50Then C=0.75 x $50 = $38

MPC: change in consumption resultingfrom an unit change in income

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Chain Reaction

MPC=0.75

50 x 0.75=3838 x 0.75 =2929 x 0.75 = 22

Spending multiplier= 200/50=4 tax multiplier= 150/-50=-3

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Spending Multiplier & Tax Multiplier

Spending Multiplier = = 11-MPC

e.g.: if MPC = 0.75,Then spending multiplier = 1/(1-0.75) = 4

Tax Multiplier = 1- Spending multiplier

e.g.: if MPC = 0.75,Then spending multiplier = 1/(1-0.75) = 4Tax multiplier = 1-spending multiplier = 1- 4= -3

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ExerciseIf the MPC is 0.75: How much will AD increase by with an increase in

government spending of $50 billion? What will happen to AD with a cut in G spending

of $25 billion? What will happen when government increasestaxes by $50 billion?

What will happen when government increasestaxes by $50 billion and increases governmentspending by $50 billion?

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Spending multiplier = 1/(1 MPC)

2 6

Derivation of spendingmultiplier

Basically, it is just a geometric summation when the number ofterms approaches infinity.

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The Multiplier Effect

Price

level

Quantity ofOutput

Aggregate demand, AD 1

An increase in government purchases of $20 billion can shift the aggregate-demandcurve to the right by more than $20 billion. This multiplier effect arises becauseincreases in aggregate income stimulate additional spending by consumers.

AD2 AD3

$20 billion

1. An increase in government purchases

of $20 billion initially increases aggregatedemand by $20 billion . . .

2. . . . but the multiplier effectcan amplify the shift inaggregate demand.

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Limitation of Multiplier it may change from one time to time does not consider crowding-out effect empirically hard to estimate

approximately between 1 1.5 in practice

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Crowding-out effect

The crowding-out effect Offset in aggregate demand Results when expansionary fiscal policy raises the interest rate Thereby reduces investment spending 2

9

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The Crowding-Out Effect

Interestrate

Panel (a) shows the money market. When the government increases its purchases of goods and services, theresulting increase in income raises the demand for money from MD 1 to MD 2, and this causes the equilibriuminterest rate to rise from r 1 to r 2. Panel (b) shows the effects on aggregate demand. The initial impact of theincrease in government purchases shifts the aggregate-demand curve from AD 1 to AD 2. Yet because the interestrate is the cost of borrowing, the increase in the interest rate tends to reduce the quantity of goods and servicesdemanded, particularly for investment goods. This crowding out of investment partially offsets the impact of thefiscal expansion on aggregate demand. In the end, the aggregate-demand curve shifts only to AD 3.

Quantityof money

0

(a) The Money MarketPricelevel

Quantityof output

0

(b) The Aggregate-Demand Curve

Aggregate demand, AD 1Money demand, MD 1

Money

supply

Quantity fixedby the Fed

MD2

r2

r1

1. When an increase ingovernment purchases increasesaggregate demand

2. . . . the increase inspending increasesmoney demand . . .

3. . . . which increases theequilibrium interest rate . ..

4. . . which in turn partly offsets theinitial increase in aggregate demand.

AD2 AD3

$20 billion

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Automatic Stabilizer

Government expenditures and taxrevenues that automatically changelevels to stabilize an economicexpansion or contraction

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$1,000

$750

$500

$250

$4 $6 $8

G S

p e n

d i n g a n d

T a x e s

G

$2,500 T

FullemploymentGDP

B u

d g e

t

d e

f i c

i t

AutomaticStabilizersContractionaryExpansionary

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Increasein real

GDP

Tax collection risesand governmenttransfer payments

falls

Contractionar

y policy to offsetinflation

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Decreasein real

GDP

Tax collection fallsand governmenttransfer payments

rises

Expansionar y to offsetrecession

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Overview of Taxation 1. Definition2. Objective3. Principle of good tax system

4. Types of Tax5. Tax base6. Tax rate

7. Tax payment8. Tax Burden9. Double taxation

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1. Definition of Tax Seligman :

Concept : tax is Compulsory

Charles M. Allan:Concept: Tax is a tool to transfer resourcebetween government and private sectors

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The system of compulsory contributionslevied by a government or other qualifiedbody on people, corporations and propertyin order to fund public expenditures.

An inherent power of the state to raiseincome and to demand enforcedcontributions for public purposes.

No direct benefit back to taxpayers

Taxation (compulsory concept)

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Income / Resources that are transferred fromprivate sector to public sector, but does notinclude government debt or income from the

sale of goods and provision of service ( at cost)by the government

Taxation (Resource transfer concept)

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2. Objectives of taxation To raise revenues for public needs so that persons can live in a

civilized society

To encourage or discourage economic activities Education, Medical care, farmer (+) Card, Alcohol beverages, Luxury goods (-)

To stabilize economy Expansionary V.S. Contractionary policy

To redistribute income An instrument of fiscal policy influences the direction and

structure of money supply, investments, credits, production,interest rate, inflation, prices and in general, of the nationaleconomy

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. The Role of TaxationOne potential classification of government functions from an

economic perspective would be Efficiency

To reduce distortions in competition. To alleviate the problems of incomplete markets

Equity To provide merit goods To alleviate poverty.

Stabilization (Macroeconomic Management) To manage risks individuals face (insurance). Macroeconomic stabilization

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Taxation has a role in each ofthese1. Efficiency

Controls externalities. Raises revenue for the provision of public goods.

2. Equity

Can redistribute income Can generate revenues that provide other forms of poverty

alleviation.

3. Stabilization

A key instrument in controlling aggregate demand And the balance of trade

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Principles of Good tax system?

Fairness Adequacy

Simplicity Transparency Efficiency

Administrative ease.

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Horizontal equity means that taxpayers in similarfinancial condition should pay similar amounts in taxes .Equal should be treated equally

Vertical equity means that taxpayers who are better offshould pay at least the same proportion of income intaxes as those who are less well off. Vertical equityinvolves classifying taxes as regressive, proportional, orprogressive.

Unequal should be treated unequally

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Regressive tax: A tax is regressive if those with low incomes pay alarger share of income in taxes than those with higher incomes.Almost any tax on necessities is regressive because lower income

people must spend a larger share of their income on thesenecessities and thus in taxes.

Proportional tax: A tax is proportional if all taxpayers pay the sameshare of income in taxes. No taxes are truly proportional. Propertytaxes often come closest since there is a close relationship betweena households income and the value of the property in which theylive. Corporate income taxes often approach proportional becauseone rate applies to most corporate income.

Progressive tax: A progressive tax requires higher-incomeindividuals to pay a higher share of their income in taxes. Thephilosophy behind progressive taxes is that higher income peoplecan afford and should be expected to provide a bigger share ofpublic services than those who are less able to pay.

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While no system of taxes is perfect, it is important to seekhorizontal equity because taxpayers must believe they aretreated equally. It is just as important to seek vertical equity sogovernment does not become a burden to low-incomeresidents

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Adequacy : Taxes must provide enough revenue to meet the basic needs of

society. A tax system meets the test of adequacy if it provides enough

revenue to meet the demand for for public services, if revenuegrowth each year is enough to fund the growth in cost of services,and if there is enough economic activity of the type being taxed so

rates can be kept relatively low.

Transparency : Taxpayers and leaders can easily find information about the tax

system and how tax money is used. With a transparent tax system, we know who is being taxed, how

much they are paying, and what is being done with the money. Wealso can find out who (in broad terms) pays the tax and who benefitsfrom tax exemptions, deductions, and credits.

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Efficiency Minimize the excess burden Fiscal neutrality The correction of externalities

Administrative ease The tax system is not too complicated or costly for either

taxpayers or tax collectors .

Rules are well known and fairly simple, forms are not toocomplicated, it is easy to comply voluntarily, the state can tell iftaxes are paid on time and correctly, and the state can conductaudits in a fair and efficient manner. The cost of collecting a taxshould be very small in relation to the amount collected.

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4. Type of Tax Level of Government

Federal Tax: PIT, CIT, Custom, ExciseLocal Tax : Signboard Tax,

Burden of Tax Direct taxes are paid by taxation on the income of the wage earner. This

form of taxation is unavoidable, and for simplicity usually collected before

the worker collect his/her wages. : income taxIndirect taxation is often avoidable and is not taken from wages. Anexample of indirect taxation is VAT (Value Added Tax) or sales tax placed ongoods and services. This is tax, but not all people have to pay it, and canchoose not to.: VAT SBT stamp duty Excise tax Custom tax

The benefits and costs of both forms of taxation are many. Direct taxation

reduces the incentive to work, as 'take home' pay is reduced as a result of anincrease in income tax compared to unemployment benefits. On the other hand,indirect taxation may result in people with similar incomes and wealth payingdifferent amounts, simply as a result of slightly different circumstance. Forexample, someone who has to travel 50km to work every day will pay more taxover the year than another who can walk, even though they may earn the sameamount and use the same public services, etc...

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4. Type of Tax Tax Assessment approach

Ad valorem Tax : Tax based on the value of good Unit tax/Quantity Tax : Tax designed so that the consumer pays a

certain amount for each unit of a particular good that he purchases

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Main Taxes in Thailand Personal income taxCorporate income taxValue added tax

Specific business taxStamp dutyPetroleum income taxCustom taxExcise taxLocal tax

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Income Base Consumption base Asset base (Wealth) Other bases Airport tax, Road tax

5. Tax Base

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Flat rate/ proportional tax Rate is flat and independent of tax base

Progressive rate

Rate is higher when the base increases

Regressive rate Rate is lower when the base increases

6. Tax Rate

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Tax rate

Tax Base

progressive

Proportional

Regressive

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Self AssessmentTaxpayers have to file the return, calculate the tax

liability and make a tax payment by themselves at thetime and place specified in the tax law

Authority Assessment Taxpayers have to file the return informing all relevant

information used to calculate the tax liability but do nothave to make a tax payment until they are informed by

the tax authority the amount of tax liability to be paid. Under self assessment system, if the taxpayer fails to

self assess tax liability or make incorrect assessment,tax authority has the right to make tax assessment withpenalty and surcharges.

7. Tax Payment

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Withholding Tax Withholder: Payer of the income

Time to withhold: when the income ispaid

Tax withheld can be used as credit againsttax liability.

If amount of tax withheld is higher thanactual tax liability, taxpayer can ask for thetax refund.

7. Tax payment

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8. Tax burden Legal burden Real burden

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9. Double taxation Economic Double taxation

Taxation of the same income twice in the hands ofdifferent taxpayers

Elimination of double taxation : Participation exemption,

dividend tax credit

Juridical Double Taxation Taxation of the same income twice in the hand of the same

taxpayer by different states

Elimination of Double taxation:

DTA: Exemption method , credit method

T di

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Steps to solve tax dispute Administrative measure: Appeal the tax

dispute to the Appeal committe

Judicial Measure: Take the dispute to thecourt

In Thailand taxpayers have to follow the step byappealing the dispute to the Appeal committeefirst and if the taxpayers do not agree with thedecision of the Appeal committee, they can bringthe case to the court.

Tax dispute

P l

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Civil Penalty Fines and surcharges

Criminal penalty Fine, imprisonment or both

Penalty

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Tax Policy

Is used as a fiscal tool to achieve economic goals Allocation of resources: high tax rate for luxury goods and

low tax rate or no tax for necessary good

Growth of economy: Tax scheme to promote SMEs ,Scheme to promote Investment

Economic stability: expansionary vs contractionary fiscalpolicy

Fair distribution of income: Direct vs indirect tax, flat rate vs

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econtax1&2_2557[1]