Personal Income Taxation and Its Effects on Economic Development and Growth

Personal Income Taxation and Its Effects on Economic Development and Growth

Bistra Svetlozarova Nikolova (University of Economics, Varna, Bulgaria)
DOI: 10.4018/978-1-7998-4933-9.ch008


This chapter reviews traditional and contemporary concepts of income taxation and their effects on economic development and growth. The author focuses on discussion issues related to the contemporary concepts of income taxation. The author also considers modern functions of personal income taxes relating to environmental protection and income inequality mitigation. Additionally, the author studies the potential of personal income taxation to apply as an instrument for maintaining sustainable economic development and social stability. This chapter analyzes the effects of progressive and proportional personal income taxation on economic development and growth. It presents a technological model of inspections and audits with the aim of improving the tax and social security control of individuals.
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Personal income taxation occupies a central position in the tax system. Additionally, it is one of the most discussed topics during the tax policy implementation since it has a significant impact on economic development and growth. Regardless of the usage of different methods of assessment and different sources of information, results of scientific research (Staykov, 2016) show that tax level has serious effects on economic growth. This is true even after researchers have eliminated the impact of factors such as government expenditure, business cycle development, and monetary policies.

Tax subjects, syndicates, any representation organizations of employers, government, and political parties, demonstrate heightened interest and sensitivity to income taxation of individuals and social security contributions. All of them have certain interests in the said aspects, which are often contradictory. For that reason, it is usually hard to reach a consensus on income taxation of individuals and social security contributions, and any decisions taken are regularly reconsidered and subject to changes in order to encourage economic development and growth. Moreover, in the contemporary socio-economic conditions, issues such as income inequality, the harmful effect on the environment, and disturbance of ecological equilibrium come to the forefront of conversations. Thus, efforts of scientists and the government aim at ensuring conditions of sustainable economic development and growth through the implementation of the macroeconomic and tax policy. Stiglitz (2012) points out that the nature of growth is what is significant, and thus, the aspiration should focus on such growth that does not aggravate people’s welfare and jeopardize environment.

The issue of finding a balance between economic effectiveness and social justice regarding taxation is related to the aim of ensuring both growth and sustainable economic development at the same time. Hristov (2014) points out that the supporters of the concept of the “minimal state” defend the thesis of limited state participation in the economy, low taxes and reduced government spending, which, according to them, stimulates economic growth and welfare of society. In this way, the funds will remain available to the private sector, which is considered to be able to spend them efficiently. This will reduce budget expenditures and the role of the state in the economy. Instead, Stiglitz (2012) proposes an alternative approach to stimulating the economy: simultaneously increasing taxes and spending so that the current account deficit remains unchanged. According to him, such a strategy will be based on a proven principle called the balanced budget multiplier. He acknowledges that taxes “suffocate” the economy, but costs stimulate it, and points out that the stimulus effect is significantly greater than the contraction effect of the economy. Stiglitz argues for the need to achieve greater economic efficiency and more equality at the same time. In this regard, he recommends the introduction of progressive income taxes. The author gives Scandinavian countries as a positive example of a nation’s prosperity in the utmost degree in modern conditions, where the state’s role in economy is enhanced through active redistribution of income and significant investments in public goods. The alternative for economic development, which Stiglitz argues, requires a better balance between the state and the markets. He believes that in these alternative frameworks, one of the roles played by the state is to redistribute income, especially if the results of market processes are highly contradictory. Soldatos (2016, p. 261) states: „There appears to be in operation a New Keynesian version of the national and international economy. Should tax policy be conducted as prescribed by this school of thought? The answer to this question lies beyond the scope of this paper, but one thing the spirit of the whole discussion makes sure is that taxation should be (i) inspired by the overall macroeconomic policy, (ii) accompanied by anti-monopoly policy. It is the spirit of the quest for efficiency as the driving force behind income and wealth redistribution, which is welfare-enhancing by itself and by sustaining economic growth.”

Key Terms in this Chapter

Tax Fraud: Multiple, systematic, or intentional violation of the tax law in which a taxpayer has made an intentional attempt to reduce the due amount of his tax following a plan contemplated in advance.

Wagner Law: Public spending increases faster than the national production growth.

Tax Compliance: Voluntary compliance with the tax legislation measured by three indicators: filing a return (filing compliance), equivalence between the amount declared and the amount actually due (reporting compliance), and payments of any liabilities declared (payment compliance).

Tax Wedge: Any taxes and social security contributions on labor as a share in the labor costs.

Gray (Informal) Economy: Market production of goods and services, whether legal or illegal, which is not included in the official statistics for GDP calculation.

Public Goods: Accessible to anyone. Examples include the national security and defense, jurisdiction, state governance, education and scientific research, health care, social security, and infrastructure.

Sustainable Development: Development satisfying the necessities of the present without taking away the chance of future generations to meet their own needs.

Unemployment Trap: This arise in the case of generous benefits and assistance programs for the unemployed, on the one hand, and heavy taxation for the low-paid, on the other. In these cases, there is very little difference between income from work and income of the unemployed, which reduces the motivation to participate in the labor market.

Gini Coefficient: An economic indicator describing the difference between the income and welfare of the poor and the rich in the society. The “0” value shows a full equal standing, and the “1” value shows absolute lack of equal standing.

Social Justice: Solidarity in meeting risks and equality of opportunity, which can be achieved through the redistribution of income in a market economy, respect for human rights and the dignity of every individual in a democratic society.

“Laffer's Type” Effects: With a tax burden increase, the state revenue grows but to a certain point, and then any additional tax rate rise leads to a revenue reduction.

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