Implication of the Optimal Tax Theory by the Reality of Tax Policy and Administration (Essay Sample)

Full Title of the Paper Name of the Student Name of the Course Name of the Course Instructor Date Implication of the Optimal Tax Theory by the Reality of Tax Policy and Administration Introduction The theory of optimal taxation has been the reigning normative approach to taxation for economist since the time of Adam Smith. At that time, useful insights about the relationships between tax instruments of government, the structure of the economy and the objectives of tax policy were generated (Slemrod, 1990). This paper aims to show the challenges and incompatibility of the optimal tax theory with the practical way of tax collection and administration. The optimal tax theory is incompatible because it has not factored in the coercive nature of taxing and collecting revenue from persons who more or less would resist. By implication, the cost of running a tax system is huge and this has been a factor policy makers consider when determining the appropriate tax policy to raise. I will begin this paper with the principal propositions of optimal tax theory pointing out the key realities of tax collections. Thereafter I shall talk about the influence the theory has on tax administration. Optimal Tax Theory There are various methodological assumptions to which the standard approach of optimal taxation is based upon. These include a certain amount of revenue is raised by the government, the decisions must remain consistent along with the optimization of the firm, the limitation to the types of taxes the government has, and the various choices are made which are to maximize the social welfare function. The results which have been achieved from the particular framework is the based on the tax instrument types which remains to be selected by the government. The Ramsey Rule states that the commodity tax rates designed by the government must have an aim to achieve equal proportional reduction in the demands for commodities. This is to make efficient and smooth operations and also because the goods that have an elastic demand must be charged with lower taxes on the basis of efficiency grounds. However, on the basis of the equity grounds, this focuses on putting lower rates of taxes on the goods consumed by the people that have lower income in the country. In simpler words, on the basis of the equity grounds, the rich people with higher income, there shall be a higher income tax. However, under special conditions after-tax income are to be equalized by the income taxes along with the implying 100% marginal tax rates. On the basis of efficiency grounds, the optimal tax has a procedure where a lump-sum amount of taxes are charged, while there is no concern for the commodity taxes. While considering the basis of the equity grounds, the income along with the commodity tax rates are used while charged a certain amount for deducting tax. Although there are some restrictive conditions in the particular setup which requires the commodity tax rates to be uniformed when the commodity tax rates have been imposed in the presence of optimal tax income. This is due to the fact that only the optimal income tax is implemented. Therefore, the optimal rule for the tax is to balance the consideration for the equity and as well as the efficiency. It has been argued by various authors and tax experts that the particular framework ignores a certain optimal tax standard, or it does not consider certain principles which is important in designing the taxes. It is argued that the optimal tax theory does not cost much to the firms or the individuals in paying their taxes. There is very little argument which can prove this argument wrong for a number of reasons. There are various compliance cost in taxation for a number of individuals and firms in the particular context. There are many different complaints which are about keeping and maintaining the record throughout a year, complication of the tax design, reaching out for the professional advice for paying the taxes, filling out the forms of returns, and other similar reasons due to which the taxes are either delayed or unpaid. Even the basic economic theory or analysis would identify the one would always expect to pay their taxes in order to avoid incurring cost which may gradually increase in the future years and remain a burden. According to Alm (1996) "No one likes the loss of income from taxes, and people will clearly take actions to avoid (or reduce) their liability. It is a standard result in economics that agents will increase their actions up to the point where the marginal benefits of their actions - in this case, the reduced taxes - equals the marginal costs - or the compliance costs - of the actions. On the margin, then, the costs of paying taxes should be approximated by the tax savings from the array of legal tax avoidance schemes that taxpayers have pursued, the accuracy of the approximation depending largely upon the way in which the marginal costs of compliance increase with the extent of their magnitude”. The government has also been underperforming when collection of taxes are concerned. The reason is because the government lacks a proper and systematic work which can be proven in the budgetary information which clearly states that the various types of taxes which includes individual taxes, business taxes, and other sales taxes are over the one percent mark amongst the revenues which is collected from the taxes. This remains substantially higher than the others as discussed by (Vaillancourt, 1989; Sandford, 1995). In the developing countries, administrating the tax income and administrative dimensions of taxes has long been an important issue (Bagchi, Bird, and Das-Gupta, 1995). However, it has recently been updated that the administrative cost is formally now included amongst the optimal taxation. Optimal Tax System and Tax Administration Operating the tax system requires the participation of millions of people which pays their taxes along with the various professional individuals which deals and maintains the record for taxes. Furthermore, another thing which remains to be required by the operating tax system is the billions of dollar budget of the Internal Revenue Source (IRS) and the counterparts of the states. There is a huge amount of money associated with the operating of a tax system which could be understood through administrating the tax collection system along with the individuals’ or the firms’ compliance to pay the taxes. The cost of the particular tax operating system is said to be estimated at $35 billion annually which also constitutes to be 7% of the total revenues (Slenrod and Sorum, 1984). In both ways the distortionary costs and the absolute terms, the cost remains very high for the tax operating cost. Conclusion There shall always be a particular situation considered by people while dealing with the law at hand. It reduces the compliance costs along with the administrative costs in eliminating the necessities of taking measures for tax bases. The proportional taxes reduces the distortion and the changes from the prices of the commodities. The government must form an administering the policy which requires them to enforce a tax rule through which the corruption should be minimized and each individual shall be able to provide taxes to the government in a legal manner. References American Bar Association, Committee on Simplification of the Section on Taxation. "Complexity and the Personal Consumption Tax," Tax Lawyer, Winter 1985, 35, 415 42. Bagchi, Amaresh, Richard Bird, and Arindam Das-Gupta. 1995. "An...