Every government is tasked with the important duties of accelerating economic growth, social development, redistribution of the benefits of economic growth, removal of income inequalities and allocation of resources.
To deliver these services and to finance day-to-day activities, the government needs an income. Some of the most important sources of government income are derived from taxation, administrative incomes, incomes from public property and increases in national debt.
Taxation is a pillar of every country’s economy, and its collection is one of the major issues in economic development. The resources available to a country are limited, so if the government wants to increase expenditures, it has to come from a reduction in private spending. This is done through a transfer of resources from the private sector to the public sector, with taxes being the main tool in doing so.
The capacity of an economy to grow depends upon the government’s ability to tax. The better the taxation system, the more help a country has in attaining sustainable growth and macroeconomic stability.
From the tax money, the government provides services like education, healthcare systems, pensions for the elderly, unemployment benefits, public transportation, energy, water and waste management systems, etc. A portion of taxes also goes in paying off state debts and interest accrued on them.
Tax policies differ in developed and developing countries. An example of modern taxes is the wealth tax, which is generally employed to target the richer populace which owns expensive assets and properties and has the capacity to pay for them. This is a kind of direct tax. A direct tax is considered an effective tool in helping economic benefits trickle down to the poor, while discouraging the concentration of wealth in a few hands.
The wealth tax improves the fairness of most tax systems, as it effectively raises government revenue, improves economic growth and reduces income inequality. It has been observed that a wealth tax that decreases other tax burdens – such as income, capital gains, sales, value added and inheritance – increases the time horizon for investment and can increase the return on investments over time.
Greater economic equality has also been correlated with higher levels of innovation. Increased government revenue from a wealth tax can be pumped into the promotion of public investment in education, health, housing services, research and development, and transportation infrastructure, which leads the economy to a path of efficiency and equity.
However, there are some inherent flaws in the wealth tax regime. There is an attendant possibility of capital flight, brain drain, loss of jobs, and ultimately a net loss in tax revenue.
Furthermore, the valuation of illiquid assets – e.g. real estate, privately owned businesses, antiques, art etc – can be purely arbitrary. Due to money supply fluctuations, there are dynamic changes in wealth valuation over time. This creates a moral hazard, whereby governments can use inflation as a direct means of raising revenue.
Due to valuation and accounting difficulties, wealth tax systems also have relatively high management costs for both the taxpayer and the administrating authorities. Thus, imposition of a wealth tax would result in flight of capital and people would start transferring money abroad. It would be a kind of double taxation, wherein a person paying income tax on an asset has again been forced to pay the wealth tax.
Nonetheless, it is a matter of great concern for Pakistan that the share of direct taxes in its revenue system has been substantially lower than that of indirect taxes. The share of personal taxes to overall direct taxes is also very low and has remained constant. This has serious implications for the economy.
Our tax system is more a system of tax exemption than the system of tax collection. The legal boundaries of the wealth tax and the political economy of such a tax are quite perplexing, but if, as a system, it is scanned thoroughly and practically instead of theoretically, it can have significant positive outcomes for the economy in general.
This article was originally published at: The Express Tribune
The opinions expressed in this article are the author's own and do not necessarily reflect the viewpoint or stance of SDPI.