Electronic copy available at: http://ssrn.com/abstract=1334957
Jerzy śyŜyński1
In charge of what the taxes are paid by individual taxpayers
Abstract
Taxes are always simply a price we have to pay for existing and operation of
the State – for the roles it plays. The main question that arises is: in charge of
what taxpayers pay their taxes. The Author shows in diagram in charge of what
taxes are paid by taxpayers of different levels of income and discusses main
consequences of this for tax policy. He shows that tax cuts for taxpayers of
different income levels give different results. Only tax cuts made in the area of low
and medium income are likely to promote global demand. So tax reforms in the
European Union made to “reinforce domestic demand” had to miss their
declared objective as mainly upper tax rates were reduced within the tax
progression scale. Demand grew up indeed – but it mainly took the form of
demand for securities on financial markets.
Taxes are always simply a price we have to pay for existing and operation of the State –
for the roles it plays. The main question that arises is: in charge of what taxpayers pay their
taxes. The answer will tell us about the structural effects of paying taxes. This is important in
the context of influence a tax system has upon global demand in economy. There is no doubt
that the global demand is determined by a structure of incomes the State generates in relation
to the structure of income it charges, due to a rate of consumption and that of savings. If it
creates a structure featuring a higher rate of consumption in relation to the structure it
charges, than the demand increases; when it creates a structure that features a higher rate of
savings, then savings will grow up and consumption will shrink.
Anyway, what is really important in this respect is not general level of taxes, but the
structure of incomes – and this is influenced by the structure of a tax system rather than by
any particular level of taxes, and mostly by a level of progression of charges that given tax
system represents: this is the factor that really has crucial importance.
1
The Author is Professor In The University of Warsaw, Faculty of Management
Electronic copy available at: http://ssrn.com/abstract=1334957
2
0
2000
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10000
12000
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18000
20000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Fig. 1. Incomes, consumption and direct taxes at various levels of income.
Let us consider now how taxes paid by taxpayers belonging to various income groups
influence their consumption and creation of their savings. The curve shown in Fig. 1
indicates2 the structure of gross income distribution in various income classes – from $1,000
to $20,000 per month, represented by a the line inclined at 45º angle; a concave curve of the
dotted line indicates the way consumption would hypothetically shape if taxes did not exist
– so it is an effect of the objective right of diminishing rate of consumption3; two thin lines
limiting the a hatched area represent taxes – we call this area “tax band”.
For most taxpayers income is the only source available to satisfy their consumption
needs, so consumption is either equal to or lower than their income. However, in the case of
some - especially poor - people, consumption may be higher than income. In such case the
line of consumption is situated above that of income (and is represented by a thin dotted
line) and a distance between them indicates deficit on a taxpayer’s expenses i.e. financing
consumption with credits or loans resulting in indebtedness or rather sellout of elements of
property – which happens as poor persons are forced to part with potential previously
accumulated property in order to satisfy their current consumption needs.
It should be observed in this context that the notion of poverty is in fact ambiguous. On
2
The graph is an illustration of hypothetical numeric values.
3
However, such a shape of the consumption curve is also only relative as it is, to a certain degree, conditioned by
the tax system.
income
income
consumption
taxes
B
C
A
Income
Consumption
taxes
3
the one hand it means earning low income – either in absolute terms or in relation to one’s
family situation (for example having many children or having to provide for other, non-
working family members), which results in one being unable to meet many objectively
indispensable needs. On the other hand, however, by the same notion of poverty we also
tend to understand a lack of property, which may stem not so much from one’s low incomes
as from one’s marginal tendency to save, lack of ability to manage one’s resources or living
“just for today”. Such a distinction between low income poverty and property poverty seems
very significant since poverty resulting from the lack of income may be only temporary,
occurring in effect of a loss of job or of general crisis or inflation leading to a decrease of
real value of income earned. It is income poverty that has crucial importance to economy
and to tax system because it implies the lack of streams to supply development.
Therefore, according with the right of diminishing rate of consumption, as the level of
income increases, the rate of consumption successively diminishes, in effect of which
consumption grows up slower than a given person’s income. In other words, wealthier
persons assign a smaller part of their income for consumption than poorer persons.
Certainly, at the same time a diminishing of the rate of consumption means an increasing
rate of savings.
In reality behaviors in groups of taxpayers are very diversified. Probably the exact
situation of the curve of consumption is stiffer in the area A-B, because at low income
differentiation of rates of consumption is less significant, whilst at higher income scales, in
the B-C area, differentiation of real rates of consumption is larger. As a consequence,
individual points of the curve of consumption could rather be described in terms of the so-
called blurred states. This way, we would have to deal with a whole family of curves within
which the one presented in the figure above could even constitute far lower limit of a series
of such curves. The curve of consumption is an effect of economic behaviors of members of
society and economic behaviors of taxpayers are also determined by the tax system itself:
savings-promoting relieves are likely to motivate people to save, thus flattening the curve of
consumption and diminishing its blur.
The income tax is thus most painful to the poorest and to the middle class (in our case up
to a level of c. $12,000 per month), since these people pay it both at the cost of meeting
their needs and of being able to save, while wealthy persons, up from a level of income
represented by point B, in reality only pay taxes at the cost of their individual savings,
because the fact of paying taxes decreases not their consumption spending4. It might be said
that for the rich taxes are neutral with respect to their decisions consumption-wise.
This graph enables us to analyze effects of tax reductions or potential increases of
income taxes may have upon demand of various income groups and, in consequence, for
4
This does not mean, however, that in the case of decreasing tax burden they are not going to increase their
consumption expenses as they may well conclude that they were in fact given an additional bonus to spend on special,
luxury purchases.
4
global demand. We see clearly that only tax cuts made in the area of low and medium
income are likely to promote global demand as they will increase real income at hand
allocated to consumption purposes, whilst reduction of taxes for rich people is (usually) not
going to push them towards greater consumption, but instead will enable them to generate
higher savings that in most cases will be turned from cash to other forms of property.
If, therefore, an aim behind tax reforms in the European Union was to “reinforce
domestic demand”5 and at the same time mainly upper tax rates were reduced within the tax
progression scale, then of course such reforms had to miss their declared objective. They
narrowed the tax band in the right part of the graph, leading, on the one hand, to increased
individual savings and, on the other hand, to potential rising of the curve of consumption or
rather blurring it even stronger. Demand grew up indeed – but it mainly took form of
demand for securities on financial markets.
5
The Reform of Taxation in EU Member States, Final Report for the European Parliament, Tender No
IV/2000/05/04, Centre d’Études Prospectives et d’Informations Internationales, Paris, April 2001, p. 5