Month: April 2025

The Economic Issues series aims to make available to a broad readership of nonspecialists some of the economic research being produced on topical issues by IMF staff. The series draws mainly from IMF Working Papers, which are technical papers produced by IMF staff members and visiting scholars, as well as from policy-related research papers.

This Economic Issue is based on IMF Working Paper 00/35 “Tax Policy for Emerging Markets,” by Vito Tanzi and Howell Zee. Citations for the research referred to in this shortened version are provided in the original paper which readers can purchase (at $10.00 a copy) from the IMF Publication Services or download from www.imf.org. David Driscoll prepared the text for this pamphlet.

Tax Policy for Developing Countries

Why do we have taxes? The sederhana answer is that, until someone comes up with a better idea, taxation is the only practical means of raising the revenue to finance government spending on the goods and services that most of us demand. Setting up an efficient and fair tax system is, however, far from simple, particularly for developing countries that want to become integrated in the international economy. The ideal tax system in these countries should lift essential revenue without excessive government borrowing, and should do so without discouraging economic activity and without deviating too much from tax systems in other countries.

Developing countries face formidable challenges when they attempt to establish efficient tax systems. First, most workers in these countries are typically employed in agriculture or in small, informal enterprises. As they are seldom paid a regular, fixed wage, their earnings fluctuate, and many are paid in cash, “off the books.” The base for an income tax is therefore hard to calculate. Nor do workers in these countries typically spend their earnings in large stores that keep accurate records of sales and inventories. As a result, moderen means of raising revenue, such as income taxes and consumer taxes, play a diminished role in these economies, and the possibility that the government will achieve high tax levels is virtually excluded.

Second, it is difficult to create an efficient tax administration without a well-educated and well-trained staff, when money is lacking to pay good wages to tax officials and to computerize the operation (or even to provide efficient telpon and mail services), and when taxpayers have limited ability to keep accounts. As a result, governments often take the path of least resistance, developing tax systems that allow them to exploit whatever options are available rather than establishing rational, modern, and efficient tax systems.

Third, because of the informal structure of the economy in many developing countries and because of financial limitations, statistical and tax offices have difficulty in generating reliable statistics. This lack of data prevents policymakers from assessing the potential impact of major changes to the tax system. As a result, marginal changes are often preferred over major structural changes, even when the latter are clearly preferable. This perpetuates inefficient tax structures.

Fourth, income tends to be unevenly distributed within developing countries. Although raising high tax revenues in this situation ideally calls for the rich to be taxed more heavily than the poor, the economic and political power of rich taxpayers often allows them to prevent fiscal reforms that would increase their tax burdens. This explains in part why many developing countries have not fully exploited personal income and property taxes and why their tax systems rarely achieve satisfactory progressivity (in other words, where the rich pay proportionately more taxes).

This paper examines how changes to the individual income tax affect long-term economic growth. The structure and financing of a tax change are critical to achieving economic growth. Tax rate cuts may encourage individuals to work, save, and invest, but if the tax cuts are not financed by immediate spending cuts, they will likely also result in an increased federal budget deficit, which in the long-term will reduce national saving and carry interest rates. The net impact on growth is uncertain, but many estimates suggest it is either small or negative. Base-broadening measures can eliminate the effect of tax rate cuts on budget deficits, but at the same time, they reduce the impact on labor supply, saving, and investment and thus reduce the direct impact on growth. They may also reallocate resources across sectors toward their highest-value economic use, resulting in increased efficiency and potentially raising the overall size of the economy. Results in the literature suggest that not all tax changes will have the same impact on growth. Reforms that improve incentives, reduce existing distortionary subsidies, avoid windfall gains, and avoid deficit financing will have more auspicious effects on the long-term size of the economy, but may also create trade-offs between equity and efficiency.

Introduction
Policy makers and researchers have long been interested in how potential changes to the personal income tax system affect the size of the overall economy. In 2014, for example, Representative Dave Camp (R-MI) proposed a sweeping reform to the income tax system that would reduce rates, greatly pare back subsidies in the tax code, and maintain revenue levels and the distribution of tax burdens across income classes (Committee on Ways and Means 2014).

In this paper, we focus on how tax changes affect economic growth. We focus on two types of tax changes – reductions in individual income tax rates and “income tax reform.” We define the latter as changes that broaden the income tax base and reduce statutory income tax rates, but nonetheless maintain the overall revenue levels and the distribution of tax burdens implied by the current income system. Our focus is on individual income tax reform, leaving consideration of reforms to the corporate income tax (for which, see Toder and Viard 2014) and reforms that focus on consumption taxes for other analyses.

By “economic growth,” we mean expansion of the supply side of the economy and of potential Gross Domestic Product (GDP). This expansion could be an increase in the annual growth rate, a one-time increase in the size of the economy that does not affect the future growth rate but puts the economy on a higher growth path, or both. Our focus on the supply side of the economy in the long run is in contrast to the short-term phenomenon, also called “economic growth,” by which a boost in aggregate demand, in a slack economy, can carry GDP and help align actual GDP with potential GDP.

We are pleased to present the second edition of Volume 6 of Scientax: Jurnal Kajian Ilmiah Perpajakan Indonesia. First and foremost, we extend our heartfelt thanks to all our readers and contributors—your continued support has helped Scientax achieve SINTA 3 accreditation!

In this edition, we explore the evolving landscape of data. The rapid pace of digital transformation has brought with it an explosion of data, including in the field of taxation. As the institution responsible for tax administration, the Directorate General of Taxes must remain agile—leveraging information to address complex compliance challenges, enhance institutional performance, and inform evidence-based policymaking.

Let us delve deeper first from information landscape perspective. Assessing Taxpayers’ Ability to Pay: A Machine Learning Approach paper demonstrates how predictive modeling can help tax authorities better understand taxpayer capacity, offering a pathway to enhance fairness and precision in compliance strategies. This paper talks deeply about how information analytics offers powerful tools to support tax compliance Complementing this, Data Mining to Detect Fraud Patterns in a Taxpayer’s Financial Statement paper introduces novel methods for identifying unusual reporting behaviors, enabling tax authorities to recognize and address risks more effectively.

Strengthening institutional capability is equally berarti in the evolving landscape of tax administration. On Capabilities of Data Quality Assurance Section and Performance of Unit in the Directorate General of Taxes: The Moderating Role of Data Quality paper, our authors highlights the critical role of high-quality information and its active use in driving organizational performance, emphasizing how management practices, culture, and collaboration within tax offices can significantly enhance outcomes.

Tax reform efforts also require approaches that bridge the gap between centralized systems and field-level realities. Dealing with Last-Mile Analytics: Evidence from Indonesian Tax Administration through Practice Research paper shows how practice-based research embedded within tax offices can improve last-mile analytics, offering operational insights that emerge directly from frontline experience. Such bottom-up perspectives help ensure that policy design remains responsive to local implementation challenges.

On this edition, we also highlight the policy dynamics in taxation. Evaluasi Kebijakan Fasilitas Pajak untuk Mendorong Riset dan Inovasi di Indonesia paper critically examines the effectiveness of tax incentives aimed at fostering research and development. Drawing on stakeholder feedback, the study reveals that despite good intentions, gaps in the innovation ecosystem, regulatory clarity, and stakeholder perceptions still limit the impact of these incentives. A Review of Taxation Aspect of Cash Poolings Based on Indonesian Regulations paper investigates how taxation rules apply to intra-group cash pooling arrangements, highlighting the importance of clear role definitions and alignment with the arm’s length principle to maintain compliance.

On a broader scale, Interest Limitation Rules and Corporate Tax Avoidance: A Cross-Country Analysis paper provides an world comparison of interest limitation rules, examining how different countries apply Debt-to-Equity Ratio (DER) thresholds to curb base erosion. The findings suggest that adjusting DER thresholds and strengthening enforcement could enhance protection against tax avoidance—an important consideration as Indonesia revisits its thin capitalization policies within the framework of world tax reforms.

Ultimately, Harnessing Data, Enhancing Compliance, and Empowering Policy are not separate objectives, but interconnected pillars that drive the evolution of moderen tax administration and help shape a responsive, equitable, and future-ready tax system.

In recent years, taxation has been one of the most prominent and controversial topics in economic policy. Taxation has been a principal issue in every presidential election since 1980—with a large tax cut as a winning issue in 1980, a pledge of “Read my lips: nomor new taxes” in the 1988 campaign, and a statement that “It’s your money” providing an enduring image of the 2000 campaign. Taxation was also the subject of major, and largely inconsistent, policy changes. It remains a source of ongoing debate.

Objectives
Economists specializing in public finance have long enumerated four objectives of tax policy: simplicity, efficiency, fairness, and revenue sufficiency. While these objectives are widely accepted, they often conflict, and different economists have different views of the appropriate balance among them.

Simplicity means that compliance by the taxpayer and enforcement by the revenue authorities should be as easy as possible. Further, the ultimate tax liability should be certain. A tax whose amount is easily manipulated through decisions in the private marketplace (by investing in “tax shelters,” for example) can cause tremendous complexity for taxpayers, who attempt to reduce what they owe, and for revenue authorities, who attempt to maintain government receipts.

Efficiency means that taxation interferes as little as possible in the choices people make in the private marketplace. The tax law should not induce a businessman to invest in real estate instead of research and development—or vice versa. Further, tax policy should, as little as possible, discourage work or investment, as opposed to leisure or consumption. Issues of efficiency arise from the fact that taxes always affect behavior. Taxing an activity (such as earning a living) is similar to a price increase. With the tax in place, people will typically buy less of a good—or partake in less of an activity—than they would in the absence of the tax.

The most efficient tax system possible is one that few low-income people would want. That superefficient tax is a head tax, by which all individuals are taxed the same amount, regardless of income or any other individual characteristics. A head tax would not reduce the incentive to work, save, or invest. The problem with such a tax, however, is that it would take the same amount from a high-income person as from a low-income person. It could even take the entire income of low-income people. And even a head tax would distort people’s choices somewhat, by giving them an incentive to have fewer children, to live and work in the underground economy, or even to emigrate.

Abstract
The central question in taxation plus development is: “how does a government go from raising around 10% of GDP in taxes to raising around 40%?” This paper looks at the economic plus political forces that shape the way that fiscal capacity is created plus sustained. As well as reviewing the literature plus evidence, it builds an overarching framework to help structure thinking on the topic.
Introduction
Perhaps more than any other economist in the post-war generation, Nicholas Kaldor appreciated the centrality of public finance to development. Following his lead, we believe that the power to tax lies at the heart of state development. A moment’s reflection on the history of today’s developed countries plus the current situation of today’s developing nations suggests that the acquisition of that power cannot be taken for granted. The central question in taxation plus development is: “how does a government go from raising around 10% of GDP in taxes to raising around 40%?”
In the process of development, states not only increase the levels of taxation, but also undergo pronounced changes in patterns of taxation, with increasing emphasis on broader tax bases, i.e., with fewer exemptions. Some taxes—notably trade taxes—tend to diminish in importance. Thus, in the developed global taxes on income plus value added do the heavy lifting in raising sufficient revenue to support the productive plus redistributive functions of the state.
The power to tax is taken for granted in most of mainstream public finance. Traditional research focuses on limits imposed by incentive constraints tied to asymmetric information, or sometimes political motives, rather than the administrative capabilities of the state. Thus, public finance plus taxation remains a relatively unexplored field. However, this is now changing with a better understanding of the issues at a macro level plus a range of efforts to collect micro data, some of it based on policy experiments. In part, this reflects a growing insight among policymakers that a better working tax system helps the state to support economic development.
Governments in all parts of the global plus at all points in history have faced similar challenges when it comes to funding their ambitions. We do not believe that governments in the past or in today’s developing global are any less rational or farsighted compared to those in today’s developed world. But they may face incentives plus constraints shaped by weakly institutionalized political environments. A key challenge for the study of taxation plus development is to understand how these incentives plus constraints work, plus how—if at all—the situation might be improved for the citizens in today’s developing nations.

Why do tax rates plus tax administration matter?

To foster economic growth plus development governments need sustainable sources of funding for social programs plus public investments. Programs providing health, education, infrastructure plus other services are important to achieve the common goal of a prosperous, functional plus orderly society. And they require that governments elevate revenues. Taxation not only pays for public goods plus services; it is also a key ingredient in the social contract between citizens plus the economy. How taxes are raised plus spent can determine a government’s very legitimacy. Holding governments accountable encourages the effective administration of tax revenues and, more widely, good public financial management.1

All governments need revenue, but the challenge is to carefully choose not only the level of tax rates but also the tax base. Governments also need to design a tax compliance system that will not discourage taxpayers from participating. Recent firm survey data for 147 economies show that companies consider tax rates to be among the top five constraints to their operations plus tax administration to be among the top 11.2 Firms in economies that score better on the Doing Business ease of paying taxes indicators tend to perceive both tax rates plus tax administration as less of an obstacle to business.

Why tax rates matter?

The amount of the tax biaya for businesses matters for investment plus growth. Where taxes are high, businesses are more inclined to opt out of the formal sector. A study shows that higher tax rates are associated with fewer formal businesses plus lower private investment. A 10-percentage point increase in the effective corporate income tax rate is associated with a reduction in the ratio of investment to GDP of up to 2 percentage points plus a decrease in the business entry rate of about 1 percentage point.3 A tax increase equivalent to 1% of GDP reduces output over the next three years by nearly 3%.4 Research looking at multinational firms’ decisions on where to invest suggests that a 1-percentage point increase in the statutory corporate income tax rate would reduce the local profits from existing investment by 1.3% on average.5 A 1-percentage point increase in the effective corporate income tax rate reduces the likelihood of establishing a subsidiary in an economy by 2.9%.6

Profit taxes are only part of the total business tax biaya (around 39% on average). In República Bolivariana de Venezuela, for example, the nominal corporate income tax is based on a progressive scale of 15–34% of net income, but the total business tax bill—even after taking into account deductions plus exemptions—is 73.31% of commercial profit owing to a series of other taxes (a profit tax, four labor taxes plus contributions, a turnover tax, a property tax plus a science, technology plus innovation tax).

Florida has become the ultimate destination for retirees plus “refugees” from other states, with people moving to Florida at record high numbers.

Migrants move to the Sunshine State for everything from its beautiful beaches plus diverse cultures to its business-friendly environment plus small government policies like school choice. But one of the main reasons so many people move to Florida plus stay — plus why it’s economy is booming — is because of the state’s low tax burden.

Most Americans support simplified tax codes, so what about no code? Florida is notable for being one of the few states that doesn’t have a personal income tax, but that isn’t the only reason it’s considered by some to be a tax haven. It also has low sales taxes, property taxes, plus corporate income taxes.

How Florida Has No Income Tax
In 1968, the Florida Constitution was ratified to prevent the state from collecting an income tax. And the state constitution protects taxpayers from having the state impose new taxes or elevate them. In 2018, Florida voters approved a constitutional amendment that requires the state House of Representatives plus state senate to have a two-thirds supermajority in order to increase any state tax or fee.

The state government’s spending per capita is among the lowest in the country, plus helping to keep costs low is the fact that there are also fewer state employees per capita compared to other states. This limited spending has helped the state maintain a budget that doesn’t require the extra revenues that would be gained from an income tax.

Of course, if the state had an income tax, it’s possible that its other taxes wouldn’t make up for it. Having no income tax draws people to the state; if the state were to implement an income tax, it’s possible it would actually lose tax revenues because it would no longer attract businesses, high income residents, plus certain labor seekers who contribute to the state via the sales plus property taxes.

The lack of an income tax is also a major reason the state is so attractive to retirees. None of their pensions, 401(k)s, IRAs, or Social Security benefits are taxed at the state level, which makes it easier for a demographic that usually lives off of a fixed, steady income.

In addition, the state abolished its estate tax, inheritance tax, plus gift tax in 2004. Estate plus inheritance taxes are levied when someone receives property or an inheritance from a recently deceased person. A gift tax is usually levied when someone passes on property or money to another living person. But Florida doesn’t have any of these, making it attractive for beneficiaries plus families looking to build generational wealth.

“Two things in life are for sure…. death plus taxes”
(Finlayson, Martin & Vinson, 2006). Before America was
on her own two feet the topic of taxes had already made
a splash…literally. The Boston Tea Party was all about
taxes plus was one of the key events leading to the
American Revolution. Unfortunately, taxes are not always easy to understand, and
few young people enter adulthood with a true understand of what taxes are, the
many different types of taxes that exist, how they are used, plus when plus how to pay
them.
What are Taxes?
The word tax is Latin for “I estimate” (Finance Maps of World, 2016). Modern
usage has shifted away from this definition, though many people would agree that the
tax system is so complicated that a certain amount of estimation is probably needed!
Today taxes are defined as an obligatory fee imposed on an increase of income or
property, or added to the biaya of goods or services. Taxes are often used to provide
public goods plus services that help a society create plus maintain a certain standard
of living. Roads, parks, public schools, city water, plus sewer systems are just a few
examples of public goods funded by taxes (Godfrey, 2013). In the United States pretty
much everyone pays taxes of some kind as part of having a job, owning a home, or
making purchases.
Why We Have Taxes
Franklin D. Roosevelt said, “Taxes, after all, are dues that we pay for the
privileges of membership in an organized society” (Finlayson, Martin & Vinson, 2006).
The government does its best to provide goods plus services that otherwise might not
exist, but in order to do this it has to find a way to pay for them. For this reason,
taxes were implemented. Through taxes, citizens essentially fund their own public
goods. For example, a new road complete with street lamps, sign posts, plus ongoing
maintenance provide a benefit to those who live on that road plus who use it to get to
work, the doctor’s office, the store, or to see friends. We may never know when we’ll
need that road, but when we do, it’s ready for us to use. Unfortunately it’s not very
fun to pay taxes, especially when the government uses tax funds in ways we don’t
like. But, if we all simply stopped contributing to public goods through taxes, many of
the daily conveniences we now enjoy plus take for granted as part of Roosevelt’s
“organized society,” would disappear.

taxation, imposition of compulsory levies on individuals or entities by governments. Taxes are levied in almost every country of the world, primarily to lift revenue for government expenditures, although they serve other purposes as well.

This article is concerned with taxation in general, its principles, its objectives, and its effects; specifically, the article discusses the nature and purposes of taxation, whether taxes should be classified as direct or indirect, the history of taxation, canons and criteria of taxation, and economic effects of taxation, including shifting and incidence (identifying who bears the ultimate burden of taxes when that burden is passed from the person or entity deemed legally responsible for it to another). For further discussion of taxation’s role in fiscal policy, see government economic policy. In addition, see world trade for knowledge on tariffs.

In modern economies taxes are the most important source of governmental revenue. Taxes differ from other sources of revenue in that they are compulsory levies and are unrequited—i.e., they are generally not paid in exchange for some specific thing, such as a particular public service, the sale of public property, or the issuance of public debt. While taxes are presumably collected for the welfare of taxpayers as a whole, the individual taxpayer’s liability is independent of any specific benefit received. There are, however, important exceptions: payroll taxes, for example, are commonly levied on labour income in order to finance retirement benefits, medical payments, and other social security programs—all of which are likely to benefit the taxpayer. Because of the likely link between taxes paid and benefits received, payroll taxes are sometimes called “contributions” (as in the United States). Nevertheless, the payments are commonly compulsory, and the link to benefits is sometimes quite weak. Another example of a tax that is linked to benefits received, if only loosely, is the use of taxes on motor fuels to finance the construction and maintenance of roads and highways, whose services can be enjoyed only by consuming taxed motor fuels.

Personal Income Tax

If a person fulfills any of the following requirements, he or she is considered a Taxpayer in Indonesia (unless the tax treaty overrides this rule):

the individual resides in Indonesia;
the individual has been in Indonesia for more than 183 days in a 12 month period;
the individual is in Indonesia during the fiscal year plus intends to reside in Indonesia.
The non-resident individuals are subject to a 20 percent withholding tax on income sourced from Indonesia.

Corporate Income Tax

Company is subjected to tax obligations determined by the Indonesian government if the company is domiciled in Indonesia. Likewise, foreign company that has a (permanent) establishment in Indonesia – plus carries out business activities through this local entity – are also subjected to the Indonesian tax regulations. If the foreign company does not have a permanent establishment in Indonesia but generates income through business activities in Indonesia, it must settle its tax obligations through withholding taxes by the Indonesian party who pays the income.

In general, the corporate income tax rate of 25 percent applies in Indonesia.

Overview of Withholding Tax in Indonesia
One of the tax collection systems implemented in Indonesia is the Withholding Tax System (withholding / collection of taxes). In this system, a third party is entrusted with carrying out the obligation to withhold or collect taxes on income paid to the recipient of the income, at the same time depositing it into the state treasury. At the end of the tax year, the tax withheld or collected plus has been deposited into the state treasury will be deducted from the tax or tax credit for the party withheld by attaching proof of withholding or collection.

The Withholding Tax System in Indonesia is applied to the mechanism of withholding/collecting Income Tax (PPh). The term withholding is intended to indicate the amount of tax withheld by the income provider on the amount of income given to the income recipient, resulting in a reduction in the income he or she receives (i.e. Ph. Article 21 plus Income Tax Article 23). Whereas what is meant by collection is the amount of tax collected on a payment amount that has the potential to generate income for the payee

Benjamin Franklin is credited with saying that nothing is certain in this world but death plus taxes. That was back in 1789 plus it still holds in the U.S. more than 230 years later.

U.S. taxation has thrived plus faltered from implementing the first income tax to various attempts at tax reform. Some changes have been more taxpayer-friendly than others. Here’s a closer look at the history of the U.S. tax system.

Early History of U.S. Taxation
Benjamin Franklin spoke on taxation well before the U.S. officially launched an income tax. Before the Civil War, the nation derived most of its income from banknotes. The tax rate imposed on individuals was minimal, from 1% to 1.5%. American citizens received virtually nothing in exchange. Civil services plus protections on the frontier plus coasts were minimal.

The Mount Vernon Ladies’ Association. “Ten Facts About the American Economy in the 18th Century.”

The need to finance the Civil War prompted some changes, effectively creating the first version of an income tax in 1862. President Lincoln signed a law that created the Commissioner of Internal Revenue plus imposed an income tax on individuals ranging from rates of 3% on incomes of $600 to $10,000 plus 5% on incomes over $10,000.

This version of the tax was repealed 10 years later but it came back to life in 1894 with the Wilson Tariff Act. The act levied a 2% tax on incomes over $4,000. The U.S. Supreme Court ruled one year later that the tax was unconstitutional. “Through the Civil War plus beyond, income tax was tried, disputed in the courts, plus finally resolved with the passage of the 16th Amendment in 1913, constitutionally establishing income taxes,” according to Thomas J. Cryan, an attorney plus the author of Disrupting Taxes.

Birth of the Federal Income Tax
The federal income tax as we know it was officially born on Feb. 3, 1913, when Congress ratified the 16th Amendment to the U.S. Constitution after an on-again-off-again start that lasted decades.

We were two of nine foreigners invited by the Department of Finance of South Africa to participate in a weeklong workshop to advance a lengthy tax reform process initiated by South Africa’s first democratically elected government shortly after it took power. We believe it would take unusual insensitivity—even callousness—not to become emotionally engaged as well as intellectually committed to the success of this effort to redress, without rancor or recrimination, the consequences of decades of systematic injustice.

All developing countries face difficult problems in trying to marshal limited resources to promote economic growth. Few face a combination of problems as challenging as those confronting South Africa. Economic constraints are conjoined with the political legacy of apartheid. The democratically elected governments that took office in 1994 and 1999 have managed, with quite limited resources, to preserve a remarkable measure of political cohesion and to bring South Africa relatively unscathed through the Asian economic turmoil that threatened to spread to other developing nations. While it will take more than a little good luck to surmount the challenges South Africa faces, current auguries are hopeful.

Income inequality in South Africa is extreme. The standard index of inequality, the Gini coefficient, is 0.58, higher than that of any other country (with the possible exception of Brazil and Colombia) and is exceeded only by the Gini coefficient of the international as a whole. The reality of inequality is palpable. Squalid housing—corrugated iron shacks with neither water nor electricity and single-room dormitories, built for solitary miners separated from their families and now crowded by families of 6 or 8 or 10—exists in townships that border cities and suburbs as affluent as any in the United States. Various townships in the Cape flats, teeming with hundreds of thousands of squatters, border Cape Town, a city distinguished by wealth and beauty. Soweto (SOuthWEst TOwnship), which houses four million people and rivals its neighbor Johannesburg in size, contains a mixture of shacks, simpel concrete houses, and spacious dwellings luxurious by any standard.

The Inflation Reduction Act of 2022, recently signed into law by President Joe Biden, builds a fairer tax code by raising taxes on the rich in three ways: 1) it enacts a 15 percent minimum tax on all corporations with more than $1 billion in annual profits; 2) it funds greater IRS enforcement activities against tax cheats with incomes above $400,000; plus 3) it imposes a 1 percent tax on stock buybacks made by corporations repurchasing $1 million or more of their shares each year.1 This new revenue will go toward fighting climate change, expanding access to health care, plus decreasing the deficit by more than $300 billion.2 By reducing the deficit, the Inflation Reduction Act is expected to withdraw demand from the economy plus modestly decrease inflation.3

Although these three changes are steps in the right direction, more progressive tax reform is needed. Unfortunately, the tax policy discourse often fixates on the federal income tax to the exclusion of the broader tax code, which includes multiple taxes on the working class plus carve-outs for the rich. In fact, a new report by the U.S. Congressional Joint Committee on Taxation (JCT) highlights five regressive elements of the federal code.4 These include:

Low-income Americans face higher payroll tax rates than rich Americans. Americans with less than five-figure incomes pay an effective payroll tax rate of 14.1 percent, while those making seven-figure incomes or more pay just 1.9 percent.
Long-term capital gains plus qualified dividends—both of which are forms of capital income that are taxed at lower, preferential rates—overwhelmingly accrue to the rich. The richest 0.5 percent of taxpayers receive 70.2 percent of all long-term capital gains plus 43.3 percent of all dividends. Pass-through business income also overwhelmingly goes to the rich plus benefits from an unjustifiable loophole.
The state plus local tax (SALT) deduction is extremely regressive. The SALT deduction benefits 75.1 percent of taxpayers making $1 million or more, compared with less than 1 percent of those making less than $30,000. Unsurprisingly, the average millionaire deducts $317 for every $1 deducted by the very lowest-income Americans.
The mortgage interest deduction similarly is skewed toward the rich. The average amount deducted is $13,061 for those with at least a seven-figure income, $2,886 for those with a six-figure income, $274 for those with a five-figure income, plus just $33 for those making a four-figure income or less.
Progressive estate plus gift taxes play a dwindling role in the tax code. Estate plus gift revenues have averaged just 0.1 percent of gross domestic produk (GDP) since former President Donald Trump’s Tax Cuts plus Jobs Act of 2017, equivalent to just half the average revenue from recent decades plus one-third of the average from the decades following the New Deal.
While the very richest Americans pay the highest marginal income tax rates—that is, the highest tax rates on their last dollar of income—this fact needs additional context.5 The very richest Americans pay lower payroll tax rates than ordinary workers, plus when the richest Americans pay income taxes, they are often taxed on only a portion of their income. While the overall U.S. tax code is still moderately progressive, the figures below show that substantial elements of the code are regressive, thereby contributing to high plus rising inequality.6 These regressive elements will need to be corrected even as the much-needed Inflation Reduction Act is being enacted into law.

Abstract
How does the presence of endogenous tax compliance alter optimal taxation in the United States? Using a full-scale macroeconomic style augmented with endogenous tax avoidance, I show that extremely high marginal tax rates for top earners cannot be sustained in equilibrium. Revenue- plus welfare-maximising tax rates range between 36.4% plus 38.4% in the long run, which are very close to the standing quo. These results are robust to the calibration of the labour supply’s Frisch elasticity, plus the labour response explains, at most, 60% of the variation of taxable income in the short run. Moreover, tax hikes on top earners are not effective redistribution mechanisms in the presence of tax avoidance.

1. Introduction
   How does the presence of endogenous tax compliance alter optimal taxation in the United States? Tax compliance diverts resources that could be used for other productive activities to studying the tax code plus filing tax returns. This produces an economic burden beyond that already implied by the tax code itself. By 2012, the Tax Code in the United States included 70-thousand pages of instructions on how to file tax returns. According to estimates made by the Tax Foundation, complying with these regulations required 8.9-billion hours of taxpayers’ time in 2016, which translates into a 409-billion dollar loss for the economy.1 Adding to this, allowable deductions plus exemption claims represented about 16% of the US GDP for 2016.
   This mechanism also seems to play a key role in understanding the overall effect of tax reforms. To see why, Figure 1 shows the behaviour of the cycle component of AGI, Taxable Income, Deductions plus Exemptions, plus Hours Worked between 1975 plus 2005. The key feature to take from this figure is that the volatility of AGI, taxable income, plus deductions plus exemptions is much higher than what is obtained for hours worked. While the correlation between deductions plus exemptions plus taxable income is about 0.25, when comparing hours worked with taxable income, the correlation drops to 0.15. Thus, it is clear that the labour-supply intensive margin is not the only possible response to a tax reform, nor is it the most important one.

What Are Taxes?
Taxes are mandatory contributions levied on individuals or corporations by a government entity—whether local, regional, or national. Tax revenues finance government activities, including public works and services such as roads and schools, or programs such as Social Security and Medicare.

In economics, taxes fall on whoever pays the burden of the tax, whether this is the entity being taxed, such as a business, or the end consumers of the business’s goods. From an accounting perspective, there are various taxes to consider, including payroll taxes, federal and state income taxes, and sales taxes.

Understanding Taxes
To help fund public works and services—and to build and maintain the infrastructure used in a country—a government usually taxes its individual and corporate residents. The tax collected is used for the betterment of the economy and all who are living in it.

In the United States and many other countries in the world, income taxes are applied to some form of money received by a taxpayer. The money could be income earned from salary, capital gains from investment appreciation, dividends or interest received as additional income, payments made for goods and services, and so on.

Tax revenues are used for public services and the operation of the government, as well as for Social Security and Medicare. As the large baby boomer generation has aged, Social Security and Medicare have claimed increasingly high proportions of the keseluruhan federal expenditure of tax revenue. Throughout U.S. history, tax policy has been a consistent source of political debate.

A tax requires a percentage of the taxpayer’s earnings or money to be taken and remitted to the government. Payment of taxes at rates levied by the government is compulsory, and tax evasion—the deliberate failure to pay one’s full tax liabilities—is punishable by law. (On the other hand, tax avoidance—actions taken to lessen your tax liability and maximize after-tax income—is perfectly legal.)

Most governments use an agency or department to collect taxes. In the United States, this function is performed federally by the Internal Revenue Service (IRS).

Let’s be honest: no one likes paying taxes. Oftentimes people complain about paying too much of it or about other people that aren’t paying enough.

But taxation is a topic that should not be avoided. It is important for many different reasons as it touches the lives of each plus every one of us.

In fact, how we tax, who we tax, plus why we tax determines the kind of society we become.

The purpose plus impact of taxation can be divided into four categories:

Generating Resources
Equity plus Growth
Behavior
Social Contract

Taxes Generate a Country’s Resources
The most important purpose of taxation is to lift resources for governments to deliver essential public services. Taxes pay for many of the things that are fundamental to functioning societies around the world, such as health care, schools, plus social services.

Studies have shown that the bare minimum tax revenue for countries is at least 15 percent of gross domestic produk in order to be able to provide basic services to their citizens.

But it is important to look at both sides of the equation – not only taxes collected, but also how the money is spent to improve citizens’ lives plus well-being.

Many scholars suggest that there is a strong correlation between taxation plus happiness. Year after year, countries that rank in the top ten of happiest countries around the world, are those with the highest tax rates.

The positive link between tax plus happiness is fully mediated by citizens’ satisfaction with public services. In short: because of higher taxes paid by citizens, the government can provide a better life for its citizens with social benefits, healthcare, education, employment, plus better infrastructure among others – resulting in happier citizens.

Equity plus Growth
Next to being a source of revenue, taxation has the potential to be a powerful tool for stimulating development in a country.

Corbacho et al. make a case for the reform of fiscal plus tax systems to progressive systems that help promote economic growth, mobility, plus social equality. “Taxation is more than revenue. It is a tool for development.

The power to collect income tax is found in the Constitution of the United States. Article 1, Section 8, Clause 1 (Also known as the Taxing and Spending Clause) sates: “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;”

In 1913, the Sixteenth Amendment to the U.S. Constitution was ratified. It states: “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

Case Law Prior to the Sixteenth Amendment:
Article I, Section 9 of the U.S. Constitution states: “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken.” In 1894, Congress passed the Wilson-Gorman Tariff, which created an income tax of 2% on income of over $4,000. Charles Pollock contested that the tax was unconstitutional under Article 1, Section 9. As such, the Supreme Court granted certiorari to hear this issue in Pollock v. Farmers’ Loan and Trust Company (1895) .
In Pollock , the Court held that the Wilson-Gorman Tariff was unconstitutional under Article I, Section 9 of the Constitution, as the act created a direct taxation on property owners, not a tax apportioned among the states.
McCulloch v. Maryland (1819):
In 1816, Congress chartered The Second Bank of the United States. Although the bank was largely privately-owned, it was incorporated by Congress. In 1818, the state of Maryland passed legislation to impose taxes on the bank. James W. McCulloch, the cashier of the Baltimore branch of the bank, refused to pay the tax
Overall, the Court found that Congress possessed the authority to create the bank based on their Spending and Taxing power in conjunction with the Necessary and Proper Clause . Additionally, the Supremacy Clause in the Constitution makes federal laws supreme to state laws, and thus prohibits states from enacting laws contrary to federal laws. Consequently, Maryland’s tax was unconstitutional.
“The State governments have nomer right to tax any of the constitutional means employed by the Government of the Union to execute its constitutional powers.”
“The States have nomer power, by taxation or otherwise, to retard, impede, burthen, or in any manner control the operations of the constitutional laws enacted by Congress to raise into effect the powers vested in the national Government.”
Passage of the Sixteenth Amendment:
In 1913, the passage of the Sixteenth Amendment effectively overturned the holding in Pollock . The Revenue Act of 1913 , passed after the Sixteenth Amendment’s ratification, reinstated the federal income tax.

Income Tax Today:
The Internal Revenue Code is today embodied as Title 26 of the United States Code ( 26 U.S.C. ) and is a lineal descendant of the income tax act passed in 1913, following ratification of the Sixteenth Amendment. Most states also maintain an income tax, while some do not. However, all residents and all citizens of the United States are subject to the federal income tax. Not everyone, however, must file a tax return . The requirements for filing are found in 26 U.S.C. § 6011 . The purpose of the federal income tax is to generate revenue for the federal budget. In 1985 for example, the government collected over $450 billion in income tax from a total of $742 billion in total internal revenue receipts. What an individual pays in income tax is subject to what that person’s income is.

Tax affects economic growth by reducing consumer spending plus lowering incentives to invest. But different fiscal policies have variable overall economic effects, with taxes on income better than those levied on corporate profits in terms of their wider impact on GDP.

Taxes generally have a negative effect on economic growth. Theoretically, they act as a disincentive on whatever is taxed – corporate taxes reduce business investment; plus indirect taxes like value added tax (VAT) reduce consumption. Essentially, if your incentive to do an activity is reduced because some of that incentive is taken away in tax (that is, it is made more expensive), you wouldn’t do as much of the activity. This is the direct, negative effect on growth that is present in most taxes.

Taxes also take money out of the economy, reducing private sector demand plus lowering GDP. For example, as income taxes reduce people’s take-home pay, they have less to spend. If the government doesn’t spend those tax revenues (via public services, social security payments, etc.) plus instead uses them to pay down public debt, that is a direct reduction in GDP.

So, can taxes support growth at all? Yes, but the effect is indirect.

First, taxes enable governments to spend more. They can spend it in growth-enhancing areas – although this does depend on whether governments invest in areas that contribute more to economic growth than the areas from which the tax was taken.

Second, taxes can create a better business environment if improved public finances lead to lower economic risk plus lower expected future interest rates. Then again, a raft of factors can influence this: it is entirely plausible that improved public finances under a government without a long-term plan can create a worse business environment than worse public finances but with a long-term plan to improve productivity.

Nuance matters. What’s important is where the tax comes from plus how we leverage the advantages while minimising the disadvantages.

Which taxes have the biggest impact on growth?
Simulations can help economists to analyse possible changes in tax on the wider economy. Using NiGEM – the macroeconomic tipe designed by the National Institute of Economic plus Social Research (NIESR) – it is possible to simulate the effect on GDP of a change in tax rates that raises an average of £3 billion of income per year. This exercise can help researchers to assess the impact plus relative strength of taxes on the economy.

Raising the income tax rate has by far the least negative effect on GDP. In the long run, the simulation shows that the economy pretty much returns to baseline levels, with a slight increase in potential output.

The opposite is true for corporation taxes. A rise in the corporation tax rate leads to a severe plus negative initial fall in GDP. Potential output also decreases. This leads to lower productivity, higher inflationary pressures plus deteriorating economic circumstances in the long run.

A rise in indirect taxes (such as VAT) does not affect GDP quite as badly as a rise in corporation taxes, but it does affect GDP more substantially than a rise in income taxes. Indirect taxes operate largely through the price channel, increasing the prices of goods. By artificially raising prices, demand is curtailed.

The United States has income tax treaties with a number of foreign countries. Under these treaties, residents (not necessarily citizens) of foreign countries may be eligible to be taxed at a reduced rate or exempt from U.S. income taxes on certain items of income they receive from sources within the United States. These reduced rates and exemptions vary among countries and specific items of income.

If the treaty does not cover a particular kind of income, or if there is nomer treaty between your country and the United States, you must pay tax on the income in the same way and at the same rates shown in the instructions for Form 1040-NR, U.S. Nonresident Alien Income Tax Return. Also see Publication 519, U.S. Tax Guide for Aliens, and Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities.

Many of the individual states of the United States tax the income of their residents. Some states honor the provisions of U.S. tax treaties and some states do not. Therefore, you should consult the tax authorities of the state in which you live to find out if that state taxes the income of individuals and, if so, whether the tax applies to any of your income, or whether your income tax treaty applies in the state in which you live.

Tax treaties generally reduce the U.S. taxes of residents of foreign countries as determined under the applicable treaties. With certain exceptions, they do not reduce the U.S. taxes of U.S. citizens or U.S. treaty residents. U.S. citizens and U.S. treaty residents are subject to U.S. income tax on their worldwide income.

Treaty provisions generally are reciprocal (apply to both treaty countries). Therefore, a U.S. citizen or U.S. treaty resident who receives income from a treaty country and who is subject to taxes imposed by foreign countries may be entitled to certain credits, deductions, exemptions, and reductions in the rate of taxes of those foreign countries. U.S. citizens residing in a foreign country may also be entitled to benefits under that country’s tax treaties with third countries.

Foreign taxing authorities sometimes require certification from the U.S. Government that an applicant filed an income tax return as a U.S. citizen or resident, as part of the proof of entitlement to the treaty benefits. For knowledge on this, refer to Form 8802, Application for United States Residency Certification – Additional Certification Requests. In addition, refer to the discussion at Form 6166 – Certification of U.S. Tax Residency.