Marginal Tax Rate In The Period 1 example essay topic

BUOYANCY AND ELASTICITY: DETERMINANTS OF LOCAL TAX SYSTEM'S PERFORMANCE By: Julhusin B. JalisanCivil servants and priests, soldiers and ballet-dancers, schoolmasters and police constables, Greek museums and Gothic steeples, civil list and services list-the common seed within which all these fabulous beings slumber in embryo is taxation. Karl Marx Every citizen, whether young or old, wealthy or poor, property owners or property-less, pays taxes to help finance governmental functions. Every business pays taxes, which almost certainly enter into the prices the consumers pay. The wages of the workers are withheld for income taxes. No one can avoid paying taxes. Taxes have always been the traditional sources of government revenues.

Recourse to taxation to finance the operational costs of government has been availed of by rulers of all times and climes from antiquity down to the present. It is what the government uses for community development. Taken in this light, therefore, taxes are not mere contributions of the people to their governments, but represent the peoples' investments for their own welfare and future. Despite this, however, and the compulsory nature of taxes, many delinquent taxpayers manage to evade or avoid the payment of their taxes in one way or another.

Tax evasion has become a serious societal problem. Too many people fail to pay their rightful tax. As a consequence, the government incurs huge deficit, and its delivery of basic services is tremendously affected. With R.A. 7160, otherwise known as the Local Government Code of 1991, providing greater degree of fiscal autonomy to local government units, a periodic evaluation of the performance of the prevailing local tax system from the perspective of resource mobilization is, therefore, an imperative task among local government units.

Estimation of Tax Buoyancy and Elasticity An important point to consider in any tax system is the responsiveness of the tax revenue to changes in income. According to Mansfield (Majuba, 1998), this responsiveness is measured by the concepts of tax elasticity and tax buoyancy. Tax buoyancy is a ratio of the percentage change in tax revenue to the percentage change in aggregate income with the revenue changes inclusive of the increment in revenue brought about by discretionary factors. Modifications in the statutory rates and bases and extraordinary changes in the degree of administrative efficiency constitute discretionary tax measures.

The growth in tax revenues (after adjustments are made for discretionary changes) reflects the growth attributable to changes in economic base and to trend changes in administrative efficiency. Thus, tax elasticity, which is based on revenue changes after adjusting for discretionary effect, is a measure of the responsiveness of tax revenues to automatic changes in economic activity and tax administration. Tax elasticity is the product of two components: (1) the base elasticity which is the elasticity of the base with respect to aggregate income; and (2) the rate elasticity which is the elasticity of the tax yield with respect to the base. The change in tax revenues during a given period is the sum total of changes in economic activity and changes due to discretionary tax measures (Trinidad, 1981). Estimation of Tax Buoyancy.

The Tax buoyancy is estimated econometric ally by regressing actual or unadjusted tax receipts on aggregate income, in either of the following equations: (1) Tt = ao + bo Yt or (2) log Tt = α o + β o log Yt where: Tt is the actual revenue inclusive of the revenue impact of discretionary tax measures at time t. Yt is aggregate income at time t. b is the marginal tax rate and serves as the coefficient of aggregate income when the linear specification is used. It is the derivative of tax revenue with respect to aggregate income, dT / dY, i.e. it is the change in tax yield per unit change in income. The tax buoyancy, n, may be derived from b by the following adjustment: (3) n = bo (Yj / Tj).

When calculated from the coefficient of a linear regression equation, tax buoyancy is variable and its value depends on the values of Y and T used in equation (3). Usually, tax buoyancy is evaluated at the means, i.e. mean values of Y and T in the estimation period, i. e., Yn and Tn are plugged in equation (3). The coefficient β o of the double logarithmic specification, equation (2), is by itself an estimate of tax buoyancy. Implicit in the use of (2) is the assumption that tax buoyancy is constant or invariable in the estimation period. Estimation of Tax Elasticity. To estimate the built-in elasticity of a tax with respect to aggregate income, the actual tax yield series will be adjusted for discretionary effects.

The various methodologies of cleaning the historical tax revenue series of discretionary effects are well expounded by Manas an (1981). Cleaning the Tax Series of Discretionary Effects. There are three major approaches to adjusting historical tax receipts series for the revenue impact of discretionary tax measures, namely: (1) Constant rate method, (2) Proportional adjustment method, and (3) Dummy variable technique. The constant rate structure method requires the calculation of the effective tax rate per income bracket (or commodity grouping) for the chosen reference year. These rates are then applied to the distribution of taxable income (values) across income brackets (commodity groupings) in all other years to generate the 'cleaned' tax series, i.e. a tax receipt series that has the same rate structure as the reference year. The feasibility of using the constant rate structure method depends on the availability of data on effective tax rates per income bracket (commodity grouping) for the reference year and the distribution of taxable income (values) by income (commodity) groupings for each year of the estimation period.

While the former is readily accessible, the latter is not, especially if one is concerned with building a series long enough for econometric work. Unlike the constant rate structure method, the other two approaches to cleaning the tax series of discretionary effects are less demanding in terms of data requirements. Primarily for this reason, this paper will focus on the other two methods. Proportional Adjustment Method. The proportional adjustment method involves a two-step process of adjusting the historical tax series for discretionary effects. First, the revenue effect of a discretionary tax measure will be eliminated from the actual tax receipt in the year in which the mea sure is enacted, i.e. year 2 receipts will be converted to year 1 rates, year 3 receipts to year 2 rates, etc.

Second, the yields in all the years will be converted to the reference year rates by multiplying the 'adjusted' annual changes, e.g. year t receipts expressed in year t - 1 rates, as obtained in step 1, less actual tax receipts in year t - 1, by the ratio of the preceding year's tax receipts stated in the reference year rates to that year's actual receipts. In symbols, lett - be the actual receipts in the j th year, Ti, j - be the j th year receipts adjusted to the it year receipts, and Dj - be the revenue effect of discretionary action in the j th year. Then if year 1 is chosen as the reference year the cleaned tax series based on the proportional adjustment method is as follows: T 1, 1 = T 1 T 1, 2 = T 2 - D 2 T 1, 3 = T 1, 2 + (T 3 - D 3 - T 2). T 1, 2 T 2 orT 1, 3 = T 1, 2. (T 3 - D 3) T 2 orT 1, 3 = T 1, 2. T 2, 3 T 2...

(4) T 1, j = T 1, j-1 + (Tj - Dj - Tj-1). T 1, j-1 Tj-1 or (5) T 1, j = T 1, j-1. (Tj - Dj) Tj-1 or (6) T 1, j = T 1, j-1. Tj- 1, tj-1... T 1, n = T 1, n-1 + (Tn - Dn - Tn-1). T 1, n-1 Tn-1 orT 1, n = T 1, n-1.

(Tn - Dn) Tn-1 orT 1, n = T 1, n-1. Tn- 1, nTn-1 Step 1 of the procedure generates the series T 1, 1, T 1, 2, T 2, 3, ... , Tj-1, j... Tn-1, n. While step 2 generates the series T 1, 1, ... T 1, 2, ...

T 1, j, ... T 1, n. The expression in parenthesis in the expression for T 1, j is the non-discretionary change in revenue between years j-1 and j. Given a tax series that is cleaned by applying the proportional adjustment method, tax elasticity will then be estimated by regressing this series of tax receipts on aggregate income using either the linear or the double log specification. The coefficients from these regressions will be interpreted in a fashion similar to that of tax buoyancy.

If the linear specification is used with the T 1, j series initially such that (7) Tt = ao + bo Yt then, the marginal tax rate of the Tn, j series, d Tn, j / d Yj is bo which is equal to (d Tn, j / d Yj) because of the multiplicative relationship between the Ti, j and the Tn, j series. On the other hand, if the double log specification will be employed such that (8) log T 1, j = α o + β o Yj then T 1, jY = Tn, jY = β o. These suggest that once the historical tax receipts series is adjusted to a given year's structure using the method of proportional adjustment then it is a breeze to translate the analysis in terms of any other years as reference year. Inherent in the proportional adjustment method is the assumption that 'the revenue effect of any discretionary measure grows in proportion to total revenue, i.e. that discretionary measures alter the level of yield but do not change the elasticity of the system' (Osoro, 1994). This implies that the tax elasticity that is measured is the average of the tax elasticity of the different structures that existed during the estimation period. Nevertheless, the method is an appropriate one in cases where (1) the discretionary measures are applied on flat rate taxes, either income or commodity taxes, such that the elasticity is neutral with the respect to rate changes, and (2) the discretionary action is assumed not to affect the base of the tax.

Dummy Variable Technique. This is an econometric method of simultaneously adjusting for discretionary revenue effects and estimating tax elasticity. Suppose that the estimation period is from year 1, 2, ... , n and that a discretionary change occurred in year k, which affected both the levels of revenue and the elasticity of the system, then a dummy variable will be introduced in an equation like (1) to indicate the change in structure, to wit: (9) log Tt = α 1 + β 1 log Yt + 1 Dt + 1 log Dt whereat = 0 for t = 1, 2, ... k-1, (period 1) = 1 for t = k, k +1, ... n (period 2) The elasticity of the system given the earlier structure is β 1 while the elasticity of the latter system is (β 1 + 1), the change in the level of revenue yield due to the discretionary after the adjusting for change in the elasticity of the tax system. Testing the significance of the parameters 1, and 1 is equivalent to testing the hypotheses that the discretionary change has affected the level of revenue and the elasticity of the tax system.

If for a priori reasons, one would rather work with the linear specification then the dummy variable will be incorporated in the estimation equation as follows: (10) Tt = a 1 + b 1 Yt + c 1 Dt + d 1 Dt. Yt where 1 is the marginal tax rate in the period 1 while (b 1 +d 1) is the marginal tax rate in period 2, and c 1 is the change in level of tax receipts due to the discretionary action holding the marginal tax rate constant. If more than one discretionary tax action took place during the estimation period, equation (7) and (8) will be generalized to include additional dummy variables. However, if discretionary changes occurred too often, then one is confronted with the problem of insufficient observations. Statistically, applying the dummy variable technique to 'cleaned' tax series is more efficient than applying it to raw data because of the one degree of freedom saved for each discretionary action. Decomposition of Tax Elasticity Tax elasticity will be partitioned into two factors: (1) the rate elasticity, i.e. the elasticity of the tax yield with respect to the tax base, B, and (2) the based elasticity, i.e. the elasticity of the tax based with respect to aggregate income.

This is seen from the following: T 1 Y = ( T 1 / T 1) / ( Y / Y) = ( ( Ti / Ti) / ( Bi / Bi) ). ( ( Bi / Bi) / ( Y / Y) ) = Ti Bi Bi Y Ti Bi will be estimated econometric ally by regressing tax receipts on tax base while By will be obtained by regressing tax base on aggregate income. LITERATURE CITEDManasan, Rosario G. "Survey and Review of Forecasting Models in Internal Government Revenues", Philippine Institute for Development Studies, No. 81-13, March 1981. Mansfield.

'Elasticity and Buoyancy of a Tax System: A Method Applied to Paraguay', IMF Staff Papers, Vol. 19, No. 2, 1972. Osoro and Leuthold. 'Changing Tax Elasticities Over Time: The Case of Tanzania', African Development Review, Vol. 6, No. 1, June 1994. Trinidad, Emmanuel and Period Sylvia de, "Buoyancy and Elasticity of Revenue", Journal of Philippine Development, Vol. V, Nos. 1 and 2, 1981. http. // web.