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What roles do taxes play in a modern economy? When designing a tax system what factors should a government consider and why?

Executive Summary

In order to route the emerging nations to the welfare and development, the global economy requires countries to find ways to compete and generate resources. It takes more than an international strategy focused on placing products and services in global markets; there is a need in the order, structure and internal state efficiency so as to streamline processes, promote new markets and offer various opportunities to companies and individuals of a country.This assignment will discuss the taxation and its role in an economy.

An economy must consider internal elements that imbue the state resources, items that meet spending, invest and sustain development programs. The government innovation in revenue generation options not only aid to facilitate the raising of funds, but also streamline processes to fulfil obligations for taxpayers.


Taxes are one of the main instruments for promoting economic development of a country. Payments or taxes consist of pecuniary character in favour of a tax creditor, which act in most of the state's laws. These taxes will finance part of social spending, and have no direct or specific consideration to the issuer.

In this assignment, I will discuss the taxation and its role in an economy. This assignment will cover the role of taxation in an economy, and factors affecting taxation system.


A tax is a money paid to the government and the state to bear the costs of resources. These mandatory payments are required for many individuals, as legal persons. The collection of taxes is the way for the State (as we know it today) to finance and obtain resources to perform its functions.

Taxes are a duty or funds that are paid as a legal standard, the money that is collected by these means how much of the money that governments are administered by a State. Unlike other types of bonds, the tax does not generate a profit directly, that is, the benefit you get is not what we see reflected directly towards us, but as activities carried out by the government(Burg 2003; McCluskey 2005).

Need for taxes

Taxes are usually implemented as a necessary mechanism for the government to have resources, but in some other cases, taxes are taxed products to modify their consumption patterns. The clearest example is the tax on snuff which aims to reduce the consumption of this commodity. This will reduce the incidence of smoking-related diseases, and reduce the cost of medical services, as well (McCluskey, 2005; Hedemann, 2003).

Taxation and economy

The role of taxation in the state's economy is large, it is necessary to fund government spending, as well as a means of fiscal and budgetary policies. Government should promote the development of small businesses, for this, it must apply to them preferential tax treatment.

The system of taxation will determine the final distribution of income among people. Without a well-functioning tax system cannot be an effective market economy. Taxes play a decisive role in the formation of the state budget(Snape 2006; Anon 2009).

The analysis of the links between taxation and economic choice is interesting in that it provides information on the economic behaviour of these agents in respect of tax.

Indeed, economic agents are changing their consumption behaviour of savings, investment and general allocation of resources, given the tax(Anon 2009; Terrance 2008).

Tax and its role in the economic balance

It is state's ability to public spending and increase the rate of economic growth depends on available financial resources needed to finance their investments, the state relies on the development of the internal sources of funding on the one hand and the use of external sources of funding on the other(McCluskey 2005; Snape 2006). It highlights the role of taxes and its importance in strengthening the internal financing and increased financial resources required by the development process. These resources are developing internal funding sources.The tax through the mobilization of resources for national development process creates an entry produces new taxes (McCluskey 2005; Anon 2009).

Role of tax in economic development

The role of the tax system is to support and entrusting the process of economic development by directing resources towards investment channels that serve the development process and increase production capacities, and redistribution of income and wealth and economic stability.

The tax policy formulated goals in harmony with the objectives of economic policy in general, so that changing the lines drawn for economic policy clearly affects the measures financial and fiscal policy in particular(Hedemann 2003).

Accordingly, usually responds tax system with economic variables and state is sufficient potential for revision of the existing tax structure and the promise of elements subject to special taxes and rates in the event of a shortfall in the state budget with the goals of fiscal policy of the state(Hedemann 2003; McCluskey 2005).

Achieving balance between privacy of the country and the nature of the composition of the tax proceeds for tax policy interact with the stage of development and provides the requirements of growth and elements necessary, particularly capital element is necessary in the process of economic development, and help to reduce the gap between savings and investment and working to mobilize financial resources to finance productive investments(Levmore 1993, pp. 265–307).

The effectiveness of the tax system to achieve economic balance stand out through the role of the system in the prevention of deviations and fluctuations is felt by the movement of economic activity(McCluskey 2005).

In UK, taxes are used to maintain the equilibrium situation and protection of economic activity from economic fluctuations and crises, because the tax policy plays a significant role in bringing balance and stability and economic organization of the size of government spending.(Burg 2003)

The role of taxes in the redistribution of income

That the goals it seeks to achieve public finances, has made taxes are important tools in the hands of the state to achieve a lot of economic and social objectives. It includes tax contribution to the re-distribution of national income, other than operating expenditures on vulnerability in the primary distribution of income(McCluskey 2005; Snape 2006).

The tax is concentrated role in the re-distribution mainly through its impact on cash incomes and real incomes and can be tax contribution to the re-distribution in the following ways:

  • change demand for consumer goods, and the consequent impact on prices, which means the effect in real incomes.
  • to raise the prices of some goods by adding taxes to it.
  • effect in the level of employment and production, and then returns the elements of production, and this is known as (the impact production), which represents the indirect impact of the taxes in the distribution of national income(Snape 2006; Anon 2009)

The role of tax systems in the resources restrictions

Today, with the renewal and improvement of the technological bases, people deal with the problem of depletion of water resources, water pollution, the inability to recover these reserves with natural mechanisms( Adler 2002). Therefore, at the present stage, one of the most prior tasks of socio-economic development of all countries pursue ecological-economical objectives, that are aimed to achieve

  • normalization of the impact of human activity on the environment;
  • the conservation of natural resources;
  • effective and efficient use of natural resources.

These problems seem to be solved subject to greening of the entire system of public administration, including the greening of such an important element as tax system.

The tax system is central to the economic mechanism of environmental management. State tax system affects the behavior of the fiscal and regulatory functions of ecological tax (Ausubel 1997).

Water use in many countries is subject to the taxation, which seems to be the prior function of government, which is reflected in the initiatives, which pursue

  • to encourage water users to implement a rational and efficient use of water;
  • to reproduce water resources through the implementation of measures aimed at protection  and restoration of water resources.

Factors in taxation policy

Tax system is two inherent and mutually opposing functions. Due to fiscal functions formed financial resources of the state. The regulatory function of taxation is shown through stimulation or inhibition growth processes of production and circulation, strengthening or weakening of capital accumulation, increasing or decreasing the effective demand of the population(Weston 2003; Terrance 2008).

According to the literature, the approach adopted by countries facing the taxability of corporate dividends is not homogeneous. There are those that totally eliminate taxation of dividends and those that mitigate or alleviate this phenomenon and also those who accept the economic double taxation. Taxable income from financial investments is not exempted in the case of individuals, nor is levied this tax most capital gains from such persons (Anon 2009; Snape 2006).

The revenue part of the budget depends on the extent of the potential taxation of the country. Potential tax countries define five factors:

1)      the level of real per capita income, and

2)      the degree of income inequality in a society, and

3)      the production structure of the national economy and the value of various types of economic activity (e.g., the importance of foreign trade, the weight of modern manufacturing industries, the degree of foreign ownership in private companies, the importance of the agricultural sector in terms of income, not just the need to provide food), and

4)      social, political and institutional conditions and the relative influence of various interest groups (federal and regional, inter-industry, trade unions and employers' organizations etc.), and

5)      expertise in administrative matters, integrity and honesty of government services for the collection of tax). (Anon 2009)

Purpose of these taxes

Taxes for the purposes for which they are used, can be of three types:

  1. Tax purposes: collections are made to fund various public services
  2. Non-fiscal purposes: fulfil a specific public interest, directly. A good example is the tax on cigarettes and alcoholic beverages
  3. Mixed Uses: combine the financing of public services with public interests (Brownlee 2004; Anon 2009)

Elements that make taxes

These payments together several interrelated elements:

  • Subject: can be active, it is one that requires the payment of taxes (national, state, federal, and municipal. It can be passive, i.e., any natural or legal person who has the obligation to pay taxes according to the laws stipulate
  • It is the activity or thing that generates taxes, notes that the Act as a reason for tax
  • Sources: are amounts or property of any person or entity, from which the amounts to pay the tax, are usually capital and labour
  • Base: is the taxable amount on which stipulates the amount of tax
  • Unit: specific quota is used to set the amount of tax
  • Fee: the amount of money received per unit tax(McCluskey 2005; Anon 2009)

Key factors affecting the tax system: 

  • Socio - economic development of the country and regions. 
  • Financial development in the country.
  • The use of new financial instruments to regulate the economy.
  • Taxation depends on the subject of taxation, on whom tax is levied.
  • Taxation depends on the form of economic activity, legal registration of business operations.
  • Taxation depends on the rules of the tax, as in the tax laws are the options for taxation, but they should be used(Anon 2009; Hedemann 2003).

The basis of taxation is fiscal function, because how consistently and fully implemented; it is possible to judge the effectiveness of the entire tax system(Burg 2003).

But from the point of view of economic sociology is the most important regulatory function of taxes. Tax mechanism is very important for the economic regulation of processes in the economic life of the country. Keep in mind that taxes can be used to suppress unwanted trends, and to drive change in the right direction for the development of society (Anon 2009; Levmore 1993, pp. 265–307). With taxes the state exercises influence on the level and dynamics of private consumption, savings and investment, structural change in the economy, solve certain social problems, etc. The main manifestation of the regulatory function is to provide a variety of tax preferences in areas such as increased business investment, small business development, etc(Anon 2009; Snape 2006).

Need for tax system

As a general rule, governments need revenue to provide goods and services to society, such as infrastructure, education, health, among others. To finance these investments, governments collect taxes, always linked to the challenge of finding a way to ensure public revenues, and in turn prevent tax evasion in the private sector. Taxes are essential for economic and social development, therefore, society and businesses have a key role as taxpayers and governments in achieving a fair tax system, stable and sustainable(Weston 62003).

The size of the tax burden on businesses affects investment and growth. In countries where taxes are high and low corporate earnings loom, companies lose interest in entering the formal sector of the economy. The increase in tax rates is associated with lower private investment and less formal enterprises. This situation is most commonly seen in developing countries where companies are limited in their profits due to the vagaries of the economy derived from its strong vulnerability to external shocks(Terrance 2008).

Taxation follows that the decision to impose tax on accounting issues, whose main task - taking into account the results of economic activity is not only promising, but incoherent. Accountant not studying law (civil and business), the accountant does not plan activities that are not engaged in economic activity, but only brings it up to the accountant to get the results that he (she) is trying to adapt to the tax legislation (Anon 2009).

They are, by definition, their specialty; confirm the reliability (and literacy) results of the accountant. That is dealing with how there was already a tax specific employer for a specific past period. Sure, they may complain that there is not anything you have done so, help hindsight something forward, but they are not tax advisers, they do not plan to taxation(Snape 2006).

For all types of production, regardless of the version of the tax system, the bottom line is that, as the profit margin has been declining share of all taxes in the amount of tax payments, except for VAT and corporate income tax, the share of which increased. This fact is confirmed by the fact that VAT is one of the major components of income tax (McCluskey 2005).

Attempts to contact a lawyer in 90% of cases result in failure.Most modestly refuses to discuss even the problem itself, the reason being that they do not specialize in this area.

Another part of the perturbation will notice that the tax law has been written by anyone, but not a lawyer, so it is not possible to understand, it is not subject to the understanding of a lawyer and does not become a lawyer to engage in such industry (Levmore 1993, pp. 265–307).

Unfortunately, only to 10 percent, or even less, lawyers who deal with business to business lawyers. Professional specialists, who call themselves tax advisor can easily usurp the same title business lawyers, not having the status of a lawyer and just for this reason. As we learned above, taxation issues are: a) in the field of knowledge about the subjects of taxation, b) in the legal formulation of economic activity, and c) in the area of tax law (Hedemann 2003).

All three of these areas are legal, the civil law, and the tax laws. The talk about the tax laws are not written by lawyers, without logic and normal terminological. This is just an excuse for those lawyers who do not want to deal with an entirely new industry, not chewed in hundreds of books and, more importantly, not far from the familiar and legal patterns, standards, and traditions.But the tax law is law; it should be the preserve of lawyers (Burg 2003).

When designing a tax system what factors should government consider and why?

Setting priorities in public administration can be based on different systems of values that are shared by the ruling elite (Rosen 2005). Recently, the practice of government has the tendency that address major public problems through the prism of economic activity, the inclusion of market mechanisms in the management of public affairs. It is believed that the economic sphere is the most crucial area. In terms of such views, governments are commercialized, transferred to the self-financing and vested broad powers to provide paid services (Bartlett 2000). Even for education and health only mandatory minimum services are secured, and they are of poor quality. Higher standard of service is available only upon payment.

Thus, it is necessary to consider a number of factors. First, the activities of the state, according to the social contract, are funded by the public through taxation. Second, the goals and objectives of the state are mainly related to the nonprofit sector.

Moreover, the public interest, which should be focused of the state, are usually associated with the "failure" of the market economy; therefore, by definition, they should be implemented for free.

Economic paradigm of government runs into self-contradiction, because from the point of view of modern economic theory, government intervention should be minimized, all the basic functions should preferably be carried out on competitive basis, governed primarily by market forces (Ripley 1966).

In addition, it should be noted that the economy of the state should be increased by the view through the prism of welfare. However, this ideal goal, as a rule, is replaced by the gross figures. Therefore, the quality and standard of living of thevarious categories of population are not taken into account, which result in losing sight of the opportunities for such sensitive issues as unemployment, inefficient allocation of resources, especially labor, the application of knowledge, and talents of people (Disney 2009). In a market economy, most people are not working in the profession, due to information asymmetries, and best jobs depend on close personal ties.

Therefore, the main  factor that should be taken into account during the tax system formation  is the welfare of the nation; however, the economic problems should not be replaced or shifted to the second place. The tax system implementation should be done through the economy growth, in order to increase the welfare of the people.

Critical Analysis

Tax system is one of the economic tools of the government that is used for the distribution of the incomes for the administration performance, social needs satisfaction and economic development influence. The tax system brings changes into the life of the country through: the increase of social expenditures for the unprotected layers of the society; the investments into the strategic spheres of the economy; the maintenance of country’s administration. Although being extremely necessary for the government machine, its use is less obvious for those who pay the taxes. A conflict between the government and tax payers is inclined into the very nature of the tax system. Anyway, effective tax system is extremely beneficial for the national development and contributes to the rising of social welfare. And, as no better system was invented, tax system remains an indispensible tool for the income redistribution throughout the society.


A good taxation policy must ensure design changes to improve their tax progressivity and revenue capacity: it must be remembered that the State has the necessary funding to sustain adequate levels of social spending, and to achieve the distributional effects are expected it is essential that the funding structure of this spending more relative strength rests on the upper income strata, rather than do it on the middle and lower strata (Brownlee 2004).

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