Introduction
“Nothing is certain but death and taxes.”, a quote attributed to Benjamin Franklin nonchalantly points out to the inevitability of taxation. It is indeed an law endured throughout the unimaginable history that one pays taxes, and although paying your taxes is considered a civic duty, doing so is mandated by the law. This naturally invokes a question of why we pay taxes to the government. Internal Revenue Service of the United States answers this by:
“The government provides public goods and services for the community as a whole. To pay its bills, the government needs revenue, or a source of income. The money that the federal government uses to pay its bills comes mostly from taxes. Taxes shift resources from private individuals and businesses to the government.”
Governments at all levels (state, regional and local) need to raise income to finance public-sector expenditures, to do so it imposes taxes. Ideally, a tax is a payment made by the people to their government so that it provides the citizens with necessary goods otherwise not provided by the private sector . These goods are called merit goods and they include public transportation, health, education, etc. The government also uses that tax they collect to improve the living standards of a country. These factors indubitably attest to the necessity of a proper tax system. The economists have put forward many theories or principles of taxation to guide the state as to how justice or equity in taxation can be achieved.
Adam Smith in The Wealth of Nations (1776) wrote:
"Such things as defending the country and maintaining the institutions of good government are of general benefit to the public. Thus, it is reasonable that the population as a whole should contribute to the tax costs. It is also reasonable to demand certain other things of a tax system – for example, that the amounts of tax individuals pay should bear some relationship to their abilities to pay… Good taxes meet four major criteria. They are:
- proportionate to incomes or abilities to pay
- certain rather than arbitrary
- payable at times and in ways convenient to the taxpayers and
- cheap to administer and collect.
This statement carries hints of modern taxation theories, namely the ability-to-pay theory of taxation. This approaches government revenue and expenditures separately. Taxes are based on taxpayers’ ability to pay. Taxes paid are seen as a sacrifice by taxpayers, which raises the issues of what the sacrifice of each taxpayer should be and how it should be measured. This theory seems simple enough, although problems arise in practice. There isn’t a consensus among economists as to what is considered a good measure for the ability to pay. Some propose property as a basis for measure, this point of view is simply refuted on the ground that if an affluent person simply doesn’t buy any property he/she could avoid paying taxes. There are some that proposed tax as a basis of expenditure and this once again evokes the same problem. Most economists are of the view that income should be the basis of measure to impose taxes.
Benefit theory is another well regarded theory according to which “The state should levy taxes on citizens according to the benefit conferred on them.” If a person benefits from the activities of the state more than others, then he should also pay more.
Some economists thought that to achieve equity or justice in taxation state could charge the actual cost of the service rendered from the people. This is the cost of service principle. The cost of service principle can no doubt be applied to some extent in those cases where the services are rendered out of prices and are a bit easy to determine, logistics services, supply of water, etc.
But most of the expenditure made by the state cannot be fixed for each individual because it cannot be exactly determined how much the activity is worth. The theories stated comprise the general concepts of most notable tax theories. Other theories exist on the other hand. A paper published by Harvard University Scholars define the framework of an optimal tax theory as:
Optimal marginal tax rate schedules depend on the distribution of ability;
The optimal marginal tax schedule could decline at high incomes;
A flat tax, with a universal lump-sum transfer, could be close to optimal;
The optimal extent of redistribution rises with wage inequality;
Taxes should depend on personal characteristics as well as income;
Only final goods ought to be taxed, and typically they ought to be taxed uniformly;
Capital income ought to be untaxed, at least in expectation; and
In stochastic, dynamic economies, optimal tax policy requires increased sophistication
(N. Gregory Mankiw, Matthew Weinzierl, and Danny Yagan)
I cited this part as I will refer to these lessons when discussing Austrian and United States Tax Code.
Austrian Tax System
In Austria, taxes are levied by the state and the tax revenue in Austria was 42.7% of GDP in 2016 according to the World bank. This is a significant rate compared to The United States’ 20% Tax to GDP ratio. Income Tax, Corporation Tax, Social Security Contributions and Value Added Tax are among the most important sources of tax revenue. The corporation tax rate is set as a flat rate of 25% and the percentage is levied on the profit of a company. A broad variety of business expenses are deductible from corporate tax. There also isn’t any tax upon profit, whereas in The United States there exist taxes on profit (trade tax). Capital gains tax is also taxed at the corporation tax rate.
Austrian Government state that they have a modern group taxation system. The idea of the Austrian group taxation is the aggregation of profit and losses of associated companies. Their claim in subsidiary companies must be more than 50% of the shares and voting rights.
The Austrian group-taxation also applies to foreign associated companies. The Austrian parent company at the top of the group can use the losses of foreign group members. The tax system is also responsive to losses on profit. Losses can be carried forward up to 75% of the current year income with no time limit. There is no carryback for losses.Income Tax on individuals are imposed progressively. There are 8 tax bands for individual income tax.
Table below depicts the marginal tax rates:
Austrian social insurance is mandatory and includes pension insurance, unemployment insurance, health insurance, and accident insurance. The contributions are computed as percentage of the total monthly earnings. The expenses are shared between the employer and the employee. The social security contributions consist a bulk of tax revenue(around 40%), this rate is around 24% in The United States.
The maximum social security rates in Austria are:
● Employer -21.7%-21.83%%
● Employee - 18.07%-18.2%
An Austrian customer must pay the net sales plus 20% value added tax. The customer effectively shares the supplier’s tax burden. The amount is then deductible from the customer’s own value added tax burden.
The U.S. Tax System
The United States of America imposes taxes on federal, state, and local government levels. Taxes are levied on income, payroll, property, sales, capital gains, dividends, gifts (no such tax exists in Austria), estates, imports etc.
No value added tax exists, albeit to the end a sales tax is no different than a VAT. The cost of each tax is passed along as a percentage of the actual value of the item either way.
Federal marginal tax rates vary from 10% to 39.6% of taxable income. State and local tax rates vary widely by local and state rulings, from 0% to 13.30% of income.State taxes are generally treated as a deductible expense for federal tax computation. In 2010, taxes collected by federal, state, and municipal governments amounted to 24.8% of GDP. The Laffer Curve Theory is noteworthy here: ”No tax revenue is raised at the extreme tax rates of 0% and 100%, and that there is a rate between 0% and 100% that maximizes government taxation revenue". It also shows that tax rates increasing after a certain point would cause people not to work as hard or not at all, thereby reducing tax revenue. William Kurt Hauser, a San Francisco investment analyst further developed this concept and concluded through empirical observation that: "No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP".
Net operating tax deduction(NOLD) is a system that is responsive to the net losses of companies when taxing them. Carry back and carry forward of tax is common practice in The U.S. similar to Austrian Tax System.
For a country with such an enigmatic taxpayer base and intricate economy as United States greater problems arise on the other hand. ”In stochastic, dynamic economies, optimal tax policy requires increased sophistication". A more complex market calls for more sophisticated solutions.
The merit of net operating loss deduction system is that if profits decline within a company the government is lenient upon the collection taxation. This arrangement however has its downsides and gaps that might be detrimental to the collection of taxes. For example, according to an article in the Forbes Magazine, which bases its report on the Government. Accountability Office report, “In 2012, out of 1.6 million corporate tax returns, only 51% were returns that had positive “net incomes,” and only 32% were returns that had positive “incomes subject to tax". The article continues by stating that NOL deduction allowed to reduce 20% of currently “profitable” their tax liability to zero.” The provision is only sensible but prone to abuse.
Just like the Austrian Tax Code the United States Tax Code imposes individual income tax in graduated tax bands. Taxpayers fall into one of seven brackets, depending on their taxable income: 10%, 15%, 25%, 28%, 33%, 35% or 39.6%. These brackets start with a similar income interval to Austrian Tax on lower brackets, however for the higher bands the income is capped at a lower maximum amount. On the other hand, Austrian Tax bands are much more responsive to changes until the 90.000 Euro band and thereafter has a flat rate between 90.000-1 million Euros. The United States Tax imposes marginal taxation in a gradual,steady manner. Following the “Tax Cuts and Jobs Act” the corporate tax rate in the United States was set at a flat 21 percent in early 2018.The effective tax rate remains at 25%. Previously the corporate income tax was 35% which was above most countries’ corporate tax rate. Introduction of new rates has set the stage for a more competitive market.
Most jurisdictions below the state level in the United States impose a tax on interests on real property . Some jurisdictions also tax some types of business personal property. Tax rates vary from state to state but generally remain between 1%-4%. The process for assessing the estate’s price also varies from state to state. Property owners have rights in each ruling to declare or contest the determined price. Property values generally must be coordinated among jurisdictions, and such coordination is often performed by a board of equalization.
The United States collects significantly less revenue dedicated to retirement, disability, and other social security programs—24 percent of total tax revenue—than the 26 percent OECD average.
References
https://apps.irs.gov/app/understandingTaxes/student/whys_thm01_les01.jsp
Optimal Taxation in Theory and Practice,N. Gregory Mankiw, Matthew Weinzierl, Danny Yagan,NBER Working Paper No. 15071 Issued in June 200
TEMPORARY TAXES TO FUND EDUCATION. GUARANTEED LOCAL PUBLIC SAFETY FUNDING. INITIATIVE CONSTITUTIONAL AMENDMENT. Proposition 55 by the Attorney General of California
Feige, Edgar L.; McGee, Robert (1982). "Supply Side Economics and the Unobserved Economy: The Dutch Laffer Curve". [Economisch Statistische Berichten]. 67 (November)
Taxation and Economic Performance by W Kurt Hauser
Forbes Magazine,Why 70% Of Companies Paid Zero In Corporate Taxes: They Had Zero Profits,Apantha Mantur