Chapter 23 - Other Tax Issues

The politics of tax reform are cyclical and prone to calls for reform to give the impression of progress. The main characteristics required of a tax regimes might be: adequate revenue, simplicity, stability, fairness, and economic efficiency. Tax reform is difficult to achieve under a democracy as ill-informed voters may prefer inefficient taxes over efficient taxes. Affluent voters tend to be more informed on tax and financial matters and tend to advance their own position strongly. When change occurs, concessions are often given to various groups of voters. Corporations with well-funded lobbyists tend to do remarkably well. The consequence is often economic inefficiency and cyclical tax revenue for the government. The effects of taxation need more study and the subject needs a better understanding by the citizenry. A government needs to make an effort to eliminate tax-related distortions in the economy. For example:

The U.S. Taxpayer Relief Act of 1997 gave deductions and credits to various groups of taxpayers, raised effective marginal tax rates for many citizens and made the tax system more complex. [1]

The complexity is often used to hide loopholes. When the government allows loopholes, one can expect that the loopholes will breed more loopholes.

Government Revenue Volatility

•Sales Tax, Income Tax, Payroll Tax and Company Tax are volatile. When there is a recession, the volume of tax collected falls. This first graph shows falls in GDP linked to falls in tax revenue.

GDP v Government Revenue by Andy Chalkley. Creative Commons Attribute.

In the above graph, you may have noticed that the fall in revenue is greater than the fall in GDP. The graph of Circulating Money Change to Tax Revenue is essentially the same graph:

Circulating Money vs Government Revenue by Andy Chalkley. Creative Commons Attribute.

•You may notice that a very small fall in the Circulating Money can cause a larger proportional fall in government revenue. State governments suffer the same indignity. Their tax collection falls significantly when there is a fall in Circulating Money:

State Government Total Taxation by Andy Chalkley. Creative Commons Attribute.


State Government Sales Tax by Andy Chalkley. Creative Commons Attribute.


State Government Income Tax by Andy Chalkley. Creative Commons Attribute.

Fall in revenue with fall in GDP is a big problem. The government becomes tempted to follow austerity economics in the belief that their economics is similar to a household budget. This is the reverse of the required government action. It is the government that is authorised to create the money of the nation, although it does not carry out this function. Irrespective, it is still the duty of the government to maintain a Money Supply, even if it does not create the money itself. In times of shortage, one might expect a little more money to be injected into the system. Although the government only spends taxes that it collects, the continuance of its spending is necessary to keep a steady state economy operating. Between 2007 and 2009, USA State and local income tax collection fell 12%. Sales tax collection fell by about 9%. Half of the USA states had shortfalls on their revenue projections greater ten percent for 2009. [2]

Property Tax revenue suffered very little during the Great Recession. [2] Property Tax provides a stable, efficient source of revenue to the government in good times and in bad.

Tax Incentives

“While granting tax incentives to promote investment is common in countries around the world, evidence suggests that their effectiveness in attracting incremental investments – above and beyond the level that would have been reached had no incentives been granted – is often questionable. As tax incentives can be abused by existing enterprises disguised as new ones through nominal reorganization, their revenue costs can be high. Moreover, foreign investors, the primary target of most tax incentives, base their decision to enter a country on a whole host of factors (such as natural resources, political stability, transparent regulatory systems, infrastructure, a skilled workforce), of which tax incentives are frequently far from being the most important one.” [4]

Accelerated Depreciation

IMF: “Providing tax incentives in the form of accelerated depreciation has the least of the shortcomings associated with tax holidays and all of the virtues of tax credits and investment allowances – and overcomes the latter’s weakness to boot. Since merely accelerating the depreciation of an asset does not increase the depreciation of the asset beyond its original cost, little distortion in favor of short-term assets is generated. Moreover, accelerated depreciation has two additional merits. First, it is generally least costly, as the forgone revenue (relative to no acceleration) in the early years is at least partially recovered in subsequent years of the asset’s life. Second, if the acceleration is made available only temporarily, it could induce a significant short-run surge in investment.” [IMF] [4]

Local Control over Local Tax

The move to Sales Tax and Income Tax has centralised the collection of taxation. This reduces local control. The reduction in the collection of Land and Property Taxes has necessitated local government obtaining handouts from state governments and state governments requiring handouts from federal governments. Thus tax collection is separated from the authority providing the services.

Sales Tax Holidays

The sales tax rate should be cut year-round. Sales Tax is a dreadful tax at anytime. Sales Tax destroys the transactions that produce tax.

Tax Evasion

Compliance Costs

Extra Reading:

“Tax Policy for Developing Countries” by Vito Tanzi and Howell Zee. International Monetary Fund. 2001-03

“Sales Tax Holidays: Politically Expedient but Poor Tax Policy” by Scott Drenkard and Joseph Henchman. 2015-08-15