Introduction In this essay I will consider whether the GDP revenue generated by personal income taxes in developing countries is low enough to be essentially disregarded as a source of income for the government
In this essay I will consider whether the GDP revenue generated by personal income taxes in developing countries is low enough to be essentially disregarded as a source of income for the government. I strongly believe that personal income taxes generate enough income for the government so that it should not be completely disregarded. I will be analysing this topic by considering arguments to impose personal income taxes, arguments that counter these claims and then refute the counterarguments.
For the purposes of my argument I will be referencing developing countries on the “more developed” end of the spectrum. This includes countries such as South-Africa, Nigeria, Croatia and Egypt. It is very common to see that in many developing countries that the corporate income tax surpasses the personal income tax. There is a way to improve the collection of personal income tax and that is to completely abandon it and rather adopt a strategy of personal consumption tax. There are various reasons however to not adopt this strategy and to retain both types of taxation. Although the margin of personal income tax collection is relatively small in many developing countries, if the design and implementation thereof is improved, it can prove to be a valuable resource for governments’ financial activities. (Bird, 2011). The personal income tax system is in most cases also the only type of progressive tax system to be found in many developing countries (Chu, 2000). It can play a role in creating a symbol for a country to induce equality and peace and create a country that is more politically stable.
The biggest counter-argument to the collection of personal income tax in developing countries is potential disintermediation from financial entities. A financial intermediary is an organisation that indirectly eases the directing of funds between the borrowers and those borrowing. In essence, the savers (people that lend) give their funds to the intermediary institution and the said institution gives those funds to the people that borrow, or spenders (Lin, 2015). Disintermediation then is reducing the use of the abovementioned intermediary entities between the consumers and producers. The argument that is made then would be that if personal income taxes are imposed in developing countries where per capita incomes are lower than in developed countries, these people would start disintermediating in order to evade taxes. The Laffer curve shows the relationship between tax rates and actual tax revenue generated. The resulting theory is that when tax rates are lifted, it is possible that the actual revenue generated from personal income tax would be lower than beforehand because of tax evasions (Investopedia, n.d.). In countries that are more developed and wealthier in general, the problem of disintermediation is not as looming because the reward gained from using financial entities, e.g. saving money is larger than the potential tax rate hikes (Gordon ; Li, 2009)
In South-Africa because of the progressive tax system, only 13% of South-Africans pay personal income tax. However, the contribution of personal income tax comprises 38% of total tax revenue, a considerable number. This is quite important to remember since the original argument in the study by Roger Gordon and Wei Li was to incorporate capital income tax rather than personal income tax. In South-Africa this would never work, considering that capital income tax contributes merely 18% to the total tax revenue, less than half that of personal income tax (BusinessTech, 2017). It is therefore obvious that personal income tax plays an absolutely critical role in generating tax income and it would be detrimental to the tax base to stop collecting personal income tax, in South-Africa at least. Furthermore, in the study done by Richard M. Bird, out of a total of 38 developing economies, only 7 of them had a capital income tax rate higher than the personal income tax rate. This indicates that personal income tax is a big part of the tax base in all of these countries, otherwise the abovementioned would not have been the case.
In conclusion, it is clear that personal income tax plays a big role in the collection of tax revenue for governments not only for developed countries but most of the developing countries as well. It would be deleterious for most countries to considerably lessen the personal income tax rate or to abolish it completely. For future studies I would recommend the analysis of the exact threat of financial disintermediation, especially considering the newfound cost-effectiveness and simplification of electronic and cardless banking, everything in order to accommodate financial minorities.