Fundamentals of Tax Reform

The fundamentals of tax reform can answer a number of questions regarding tax reforms. They carry a significant degree of importance regarding the tax infrastructure of a particular country. A number of propositions have been put forward for reforming taxes through applying the fundamentals of tax reform.

The tax system or tax infrastructure should be flexible regarding equity financing and financial engineering so that companies do not face any difficulties in having a flexible capital base for contingency situations. The tax code should be transparent or clear in nature and encourage more dividend payouts. This will result in increased formation of capital and greater opportunity for earning and employment.

In the United States, a number of important modifications have been proposed by the president, which include accelerated margin rate cuts, elimination of dividend tax and elimination of capital gains tax on retained and accumulated earnings. There are basically two goals behind these modifications, one is cutting down both cost of capital regarding investment and capital taxes and the other goal is to neutralize the corporate funding decision. This is quite significant with regards to economic development.

In order to ensure integration of corporate tax, abolition of double taxation on earnings from corporate sources can be an effective measure.

Two studies support these moves on an empirical basis and they are the following:

• Investment studies based on econometrics
• Calculable general equilibrium model

However, the latter functions better in the context of substantial tax modifications. These models can answer a number of questions regarding the consequences of the tax modifications on the entire economy. However, these answers are based on anticipations regarding the tax infrastructure. Productivity and increased wages have a mutual and direct relationship. If productivity is high, wages will also become high due to a competitive labor market and as a result, consumption will be high as well. Ultimately, the GDP or Gross Domestic Product will also go up. The tax reforms should take into consideration this aspect.

The fundamentals of tax reforms should support the Keynesian argument. The incentives for capital formation and investment should be modified. It might take a long period of time, however, the short-term results are quite strong in nature as well. Improved taxation plans can have a positive impact on the capital market. Removal of double taxation can result in a lower degree of taxation on capital, as well as wages and in this way people can earn more.

Those tax relieves should be implemented that carry significant growth potentials. The tax structure should be simplified and it should clearly specify which items are taxable and which are not. The tax infrastructure should not be onerous and it should be transparent and comprehensible in nature. In this way, the people can have trust on the taxation system.