In this analysis
In this analysis, I summarised an academic article written by Roger Gordon and Wei Li entitled Tax Structures in developing countries: Many puzzles and a possible explanation.
This article was found in the Journal of Public Economics 93 (2009) 855-866. According to the abovementioned article, previous studies done by Diamond and Mirrlees (1971) predicted the most favourable tax structure will preserve the efficiency of manufacturing under reasonable assumptions The article’s focus is the difference between tax policies seen in developing and developed countries and how the government’s proposed tax policies differ if firms are able to evade taxes by only using cash and, in essence, making no use of the financial sector. Atkinson and Stiglitz (1976) further argued that as long as a government can choose the rates of personal income taxes, there will be no need to choose variable tax rates based on the consumer’s use of different goods. Furthermore, Friedman (1969) stated that a country would purposefully choose a rate of deflation as to generate a nominal interest rate as close as possible to zero. The reasoning behind this will be to avoid the costs of liquidity. In a much more recent study by Levine (2004) where advancements in the financial sector correlates with economic growth, this study provides additional evidence to support the findings. In fact, the paper states, it is proposed that improvements in the financial sector is foundational for any sort of tax policy adjustments.
The methods I employed to access this article included an Internet search via Google Scholar and downloading of the article from the UP-library portal.
The results of the study where the reward gained from using the financial sector is low indicated that revenue generated in terms of GDP from tax proceedings will be low, the reason for this is potential disintermediation. The actual base of taxpayers will be quite limited, restricted mostly to firms that make use of financial intermediaries. The best use of tax policies will be to include capital income taxes so that most of the tax onus will fall on the entities that will struggle to function normally without using the financial sector. Taxes in the corporate sector can help produce additional income for the government while still maintaining or reducing intermediation. By reducing excise taxes levied on more labour-intensive entities and increasing taxes levied on capital, tax income can be increased with necessarily causing disintermediation. The incentive for taxing capital income has increased proportionally. In order to recompense for the variances in taxes across the many industries of trade, tariffs will be implemented. Inflation’s main function will be to tax the mostly untaxed (all cash transactions) economic groups. The entry of overseas firms to the local market may be restricted. Overseas banks’ entry into the local economy will be disheartened because of the relative ease of which taxes can be evaded by domestic firms when banking with these foreign banks. It has been observed that tax policies in developing countries is bound to a much more significant level of red tape. Corruption amid tax officials is also at a very high level. As stated by the model, all the above-mentioned methods are optimal. It is however the chance of disintermediation that may cause the government to collect a smaller tax income. In the developed, richer countries the threat of disintermediation is not as imminent because the reward that is gained from financial intermediation is larger than the threat of tax hikes.
The study definitely revealed a few surprises, namely the considerable difference in tax policies between richer and poorer countries. The likelihood of entities disintermediating from the financial sector during the introduction of new taxes of tax hikes is also larger than previously believed. In terms of future studies, it is cardinal to firstly understand exactly why the tax approaches differ so significantly between rich and poor countries before any attempt is taken to alter these policies. It also has to be noted that the rates of tax can potentially differ, according to the industry that is under consideration. Recommendations for future studies include further research on the exact threat of disintermediation as it can only be estimated at this point. The recommendation of avoiding policies of tax imposition by banks has raised numerous questions and has to be investigated further.