As you may know the federal government taxes dividends twice - once at the corporate level and once at the individual level. That means that dividend paying corporations and their shareholders are penalized compared with some other types of investments. Part of reason for reducing the tax was to address this seemingly unfair double taxation.

If the reduced dividend tax rate expires in 2010 as now scheduled, shareholders receiving these types of payments will be subjected to higher tax rates. This will have a negative effect on investment returns.

To change this possibility it will take companies and individuals becoming actively engaged in supporting legislation that will extend the lower rate.

Nobody can know for sure what, if any, legislation will be brought forth to make the 15% rate permanent. Hopefully, each of us will involve ourselves in the political process by contacting our elected officials. Let Congress know that double taxation is unfair and encourage them to support the 15% tax rate.

In business, taxation is also a significant matter of discussion. While businesses greatly contribute to the national development through taxes, it is also important that tax systems can help businesses, especially the small ones, to grow and develop in the most effective way. However, in some cases, the issues on tax complexity and compliance appear to hinder this significant objective. In order to elaborate more on these taxation difficulties, the case of the small businesses in UK will be taken into consideration. How these taxation difficulties have affected small businesses will be highlighted based on a newspaper article from the Birmingham Post (Naqvi, 2001).

Issues and Effect

According to the article, in 2001, the UK Ministers had received several criticisms from the regional accountancy groups due to the problems on the UK taxation systems, which had greatly affected several small businesses in the country. Critics were mainly pointing out on the inability of the Ministers to consider the status of the small businesses as well as their needs for further development. According to the president of the Birmingham & West Midlands Society of Chartered Accountants Mike Russell, the main problem of the UK taxation system is brought about by the excessive tax legislations as well as the complexity of the taxation system. Due to these taxation difficulties, Russell noted that the government's role to help small businesses to progress was significantly overlooked.

Based from the details of the article, the effect of these taxation issues was significant. A total of about 2,000 members from strong organizations, who were in charge of providing advisory assistance to small businesses, had even expressed their concern over this taxation matter. Russell stresses further that tax complexity and intensive legislations affect smaller businesses during their daily business operations. This effect is encountered mainly through increased expenses as well as the time allotted for compliance.

In fact, costs derived from the implementation of a new legislation totaled to more than 8,000 pounds in 2001 for small businesses. Compared to the previous year's average cost of 4,700, the difference in figures was indeed significant. Due to the increasing complexity of the UK tax system, it has been suggested that smaller businesses would rather risk on accidental non-compliance as they simply do not have the time or resources to manage the complexity and volume of the tax legislations. Some accidentally do not comply with these regulations due to lack of knowledge.

The problem on taxation complexity has long affected most national taxation systems. In the article written by Bartlett (2004), complaints from entrepreneurs due to taxation complexity had been reported even way back 1928. Previous investigations concluded however, that the complexities in most taxation systems are brought about by the businesses themselves. Businesses nowadays are very much complex, which in turn limits the possibility for tax simplification.

In the book Perfectly Legal authored by David Cay Johnston, the increasing complexity of contemporary businesses are brought about by the purpose of the entrepreneurs to lessen their tax burdens. Nonetheless, national administrations respond to this tendency by implementing equally complex taxation systems. The effect of tax complexity does not seem to affect larger corporations. This is due to the fact that such businesses can employ tax experts or accountants to address this complexity. However, this taxation difficulty is a major burden for both smaller enterprises and individuals, particularly in terms of cost (Bartlett, 2004).

The effect of taxation complexity on small businesses has been clearly identified by the General Accounting Office. For instance, GAO has noted that about $18 billion of overpaid taxes by small businesses were accumulated for the past two years. This had been caused by tax return errors. Other reports by GAO also showed that more than two million taxpayers had overpaid their taxes as they failed to take advantage of their legal deductions (Bartlett, 2004). This article by Bartlett further supports the case of the small businesses in UK as this shows how tax complexity could only lead to excessive costs.

Solutions

The article clearly implied that small business owners tend to disregard the tax regulations implemented by the government. This is the way how the British entrepreneurs manage these taxation difficulties. Apparently, they are more concerned on how to operate and expand their respective businesses. Relevant agencies however, attempted to act on this taxation problem. For instance, the problem on funding was addressed by means of broadening the Small Firms Loan Guarantee Scheme. This action helped in dealing with finance providers asking for excessive security levels. A working party was also established by the Institute of Chartered Accountant in England and Wales in order to work on the funding problem.

Russell stated that the government's approach towards this taxation concern had been disorganized. Nonetheless, the recent actions of the government for this problem had been hindered by the EU regulations. One example of which is the Regional Capital Venture Funds proposed by the UK administration and examined by the European Commission. The approval of this proposal could have resulted to the delay of the needed funding.

There has been no clear and definite solutions given in the case; however, it has been suggested that the simplification of the UK tax system is the most efficient step to resolve this problem. In addition, there should be a great deal of consideration for effects when new legislations of taxation are being introduced. The government should first weigh the compliance burden and the cost once these legislations are observed by small businesses. It has also been suggested that the level of complexity of employment legislations, employment protection as well as health and safety measures be lessened as it greatly affect smaller enterprises. If this taxation difficulty will continue, it is likely that small businesses will limit their needs for human resource; thereby, causing danger on possible increase on unemployment levels.

There are several ways on how the UK government and small businesses can handle the problem on taxation. For instance, the taxation system can be simplified by harmonizing it as whole. The UK administration could greatly reduce compliance cost by means of increased coordination and harmonization as this will ensure that small businesses will pay the right amount of tax. The government tax agency of UK should also have a strong of cooperation, consistency, fairness and efficiency when dealing with small businesses as well as to other types of taxpayers. There should be a considerable effort from the government in disseminating information about the country's taxation system. In this way, small businesses will comply fully to tax legislations.

Ethical Considerations and Legal Implications

One of the ethical considerations related to the issue of taxation complexity and compliance cost is the role of the government for the people. National governments are obligated to help the people, and one way of doing so is through the implementation of simple and practical tax legislations. The business owners have worked hard for the taxes that they pay; hence, the government should ensure that the small businesses can fully comply with the regulations on taxation.

Considering the problem on increasing costs due to complexity, the government should be greatly concerned that the growth of the small businesses is somehow hindered due to overpaid taxes. In addition, small businesses are considered major job providers. With the increased costs due to taxation complexity, it is possible for small businesses to limit their total workforce requirement. This in turn could greatly affect the UK economy as a whole.

Ethically, there should be a strong sense of give and take between the government and the small businesses. A consensus between these two sectors should be established. Both of these sectors are operating for the benefit of several people; hence, they should coordinate on how they can enhance their public services. In terms of taxation, the government should implement a taxation policy that small businesses can conform to. Once this has been identified, small businesses should assure their full support for the government by being honest and faithful taxpayers.

If the problem on UK taxation will continue, certain legal issues could arise and affect the entire system. One of the major legal concerns about this issue is the matter on tax evasion. As implied by the article that has been discussed, small business owners manage to overcome tax complexity simply by not complying with its provisions. This behavior is likely to influence other business owners to evade their tax obligations totally, resulting to an even worst outcome. In order to resolve this matter, the government should make an effort to encourage business owners to pay their taxes. Simple taxation systems are then the key to this legal issue.

The Future

Developments on the taxation system are clearly necessary in order to resolve the problem of the small businesses in UK. These developments are needed in order to prevent future taxation-related problems for arising, including the possible increase of employment levels as well as increased problems on tax evasion. The future of the UK taxation system can be improved by means of coordinated government-business relationships, simplified taxation systems and reduced tax legislation burdens.

Taxation is a system that benefits both the government and the people. However, some issues appear to hinder the efficient implementation of this system. In this paper, the problem on taxation complexity and compliance costs was discussed. Specifically, the case of the small businesses in UK was taken into consideration. Based from the article and relevant literature, it has been shown how these identified taxation difficulties can affect small business operations. In addition to the costs incurred, substantial time needed to understand complex legislations is required. Considering that business owners have several priorities to attend to, taxation legislations are often disregarded.

In order to respond to these taxation difficulties, it is essential for the UK government to consider the status and needs of the small businesses. The taxation system should be simplified in order to prevent the cases of overpaid taxes and increased costs. This key solution will also be helpful in preventing other relevant problems such as unemployment and tax evasion. In general, the government and business owners should have a cooperative relationship in order for them to give better services to the public.

 

Further, changes in government spending/revenue collection can also lead to a reallocation of resources, which changes the pattern of production in the economy, as well as redistributing income.

Thus, the roles of fiscal policy are:

• Affect economic activity
• Influence resource use
• Affect income distribution

The budget is the annual statement from the government of its income and expenditure plans for the next financial year. It includes all forms of revenue, including:

• Direct tax (personal/company)
• Indirect tax (eg. GST)
• Other revenues (eg. dividends for public trading enterprises).

The other side of the budget is government expenditure, the main items of which are social welfare, health, education, and defense and public administration.

Changing leakages and injections in the circular flow of income is the key principle behind fiscal policy.

Budget outcomes

The overall outcome of the budget is the budget outcome (or fiscal outcome), which gives an indication of the overall impact of fiscal policy on the economy. There are three possible outcomes:

1. Fiscal surplus: G > T (withdrawals > leakages)
2. Fiscal deficit: T > G (leakages > withdrawals)
3. Fiscal balance: T = G

A deficit budget tends to increase aggregate demand (expansionary effect).

There are three measures of the Budget outcome:

1. The fiscal outcome: total revenue - (total expenses + capital investment). Considered the most accurate long-term indicator of fiscal policy, it is calculated using the accrual accounting method.
2. The underlying cash outcome: Considered the best indicator of the impact of fiscal policy on the level of economic activity, it is calculated using the cash accounting method.
3. Headline cash Budget outcome: Unlike the above two methods, this does not remove the effect of one-off transactions that can distort the Budget outcome, eg. the sale of government assets such as Telstra. It is not considered a useful indicator of fiscal policy for this reason.

The government's main fiscal policy aim is to achieve fiscal balance, on average, over the course of the economic cycle.

Changes in budget outcomes

The Budget outcome changes each year, reflecting the impact of two factors:

• Changes in fiscal policy (known as structural or discretionary changes).
  This involves deliberate changes to fiscal policy, such as changing taxation rates or increased expenditure.
• Changing economic conditions (known as cyclical or non-discretionary changes).

When an economy is in recession, the budget deficit will increase, whereas during a period of strong economic growth the deficit will contract or the Budget will shift into surplus. Budgetary changes occurring as a result of changes in the level of economic activity are also known as automatic stabilizers.
There are two main automatic stabilizers:

• Unemployment benefits - When the economy moves into recession, economic activity falls, and u/e rises. This leads to greater government expenditure on u/e benefits. Thus, a decline in economic activity automatically leads to an increase in government expenditure, and vice versa.
• The progressive income tax system - During levels of high economic activity, employment opportunities are increasing and incomes are rising. This moves workers into higher income tax brackets, and previously unemployed persons start paying income tax, increasing the level of government revenue, and vice versa.

Automatic stabilizers are built into the Budget to play a counter-cyclical role. When economic growth is high, demand is automatically slowed through higher tax revenues and reduced expenditure. On the other hand, when economic growth is low, it is given a boost by increased government expenditure through u/e benefits. Nevertheless, on their own, automatic stabilizers are rarely strong enough to counter the effects of the economic cycle, and so government still rely on discretionary policy measures.

Impact on economic activity

The impact on economic growth: It can expand, contract or remain neutral:

• An expanded stance: where the government is planning to increase the level of economic activity in an economy, either through reduced taxation revenue or increased government expenditure. This creates either a smaller surplus or a larger deficit than in the previous year, leading to a multiplied increase (MULTIPLIER EFFECT!) in consumption and investment and stimulating aggregate demand.
• A contracted stance: where the government is planning to decrease the level of economic activity in an economy, either through increased taxation revenue or decreased government expenditure. This has the opposite effect, dampening aggregate demand.
• A neutral stance: where the government plans to maintain the same gap between revenue and spending as it did the previous year, having no effect on economic activity.

Impact on resource use

• Fiscal policy may directly affect resource use through government spending in a particular area of the economy. This makes it more or less attractive for resources to be used in a particular way, eg. imposing a tax on polluters to minimize economic activity that damages the environment.
• Government are more likely to use direct measures if they expect that markets will not provide the resources quickly enough without government intervention, eg. in an emergency situation such as a natural disaster the government will step in to provide relief. Similarly, the government might pay directly to provide a public good, which the private sector is unlikely to pay for and is difficult to prevent others from using, eg. defence.
• governments are more likely to use specific taxation and spending policies that lead to changes in resource use that meet the government's objectives, eg. in order to discourage the consumption of products such as tobacco without banning them, the government will apply high tax rates. In the long term, this will help to reduce the costs to the health care system that arise from treating tobacco related diseases.

Impact on income distribution

Changes in fiscal policy play the most important role of any government policy in influencing the distribution of income in the economy.

Government taxation: People on higher incomes pay higher rates of income tax, allowing the government to use this revenue for social expenditure, such as welfare and community services, which in particular assist those on lower incomes.

Changes in taxation rates can significantly affect income distribution, e.g.:

• Reduced taxation rates at the upper end of the income scale would make the tax system less progressive and create a less equal income distribution
• If the government increased the rate of GST, the tax system would be less progressive and result in lower income earners paying a relatively higher proportion of their incomes in tax, increasing inequality

Government revenue: Budgetary changes involves government spending can also influence income distribution.

• Reduced government spending on community services, such as labour market programs for the unemployed, tend to increase inequality, because low-income earners tend to be more reliant on government services than higher income earners

Impact on savings and the CAD

There is a significant relationship between the Budget outcome and external stability:

1. A Budget deficit decreases national savings. As the size of the deficit increases, so too does the size of the public sector deficit, thus reducing national savings (which is comprised of public and private savings).
2. If our national savings are too low to finance our levels of borrowing for investment and consumer spending, the competition for a limited amount of savings will put upward pressure on i/r and private sector investment will be "crowded out"
3. Alternatively, the inflow of funds will come from overseas, an inflow on the capital and financial account but a debt on the net income account, increasing the size of Australia's foreign debt. This will also increase servicing costs, causing a worsening of the CAD.

On the other hand, fiscal balance increases national savings and so reduces the CAD, improving external stability.

Changes in macroeconomic policy settings may occur when the economy's equilibrium level of income or output does not coincide with the full employment level of income:

• If aggregate demand exceeds aggregate supply at the full employment level of income, an inflationary gap may emerge in the economy and result in a rising price level. Therefore, the government will respond by running a surplus budget/decreasing interest rates (which then decreases aggregate demand, returning it to equilibrium).
• If aggregate demand is less than aggregate supply at the full employment level of income, a deflationary gap may emerge in the economy and result in a rise in u/e. Therefore, the government will respond by running a deficit budget/increasing interest rates (which then increases aggregate demand, returning it to equilibrium).

The small change in aggregate demand has a MULTIPLIED effect on national income.

The consumption function - methods of financing a deficit

A deficit can be financed in four ways:

1. Borrowing from the domestic private sector - This is the main form of deficit financing, and is done by selling Treasury Bonds under a tender system. The government sets the value of bonds, which are then sold to purchasers, starting with those offering to buy at the lowest rate of interest, through to the highest. This is advantageous because:
   - the government can always be certain that it will fully finance its deficit.
   - The market will set the i/r on these newly issued bonds.
   However, running excess deficits funded by borrowings from the domestic private sector will use up funds in Australia's domestic savings pool, putting upward pressure on i/r and leading to a reduction in private sector spending and investment. The private sector is "crowded out" of the domestic market by government borrowing, meaning it will have less access to domestic savings and may be forced to borrow overseas, which has detrimental effects on external stability. If the government runs a deficit during periods of strong growth, the deficit will be more likely to lead to a significant crowding out effect.
2. Borrowing from overseas - This is advantageous because it minimizes the crowding out effects while stimulating growth. However, it also results in increase levels of foreign debt, which is detrimental to external stability. For this reason, the government has not borrowed from overseas to finance a deficit since the late 1980s.
3. Borrowing from the RBA (monetary financing) - In effect, this means printing more money. The government has avoided borrowing from the RBA since 1982 in order to avoid increased inflation. This also means that there is no longer a direct connection between monetary and fiscal policy.
4. 4. Selling assets, e.g., Telstra shares - This does not reduce the level of the fiscal deficit or the underlying cash outcome, because these are adjusted to reflect one-off transactions. However, in cash terms from year to year a government can create a headline Budget surplus by selling assets. This will still reduce national savings, as the asset purchasers still need to borrow (or use their own savings) to finance the purchase.

   Using budget surpluses

   The government can use the surplus in a number of ways:

   • Depositing it with the RBA
   • Using it to pay off public sector debt (this is the most common situation, as it reduces the size of the debt and injects the surplus funds back into the economy, which may move into other forms of savings or be spent. The increased investment may offset the contractionary effect of the surplus).
   • In the 2005-06 Budget, the government established the Future Fund as an alternative use of Budget surpluses. It enables the government to accumulate sufficient financial assets to offset the government's superannuation liability to Commonwealth public servants. The government argues that by putting away money now, it will reduce pressure on the Budget in the future, when the government will be facing increased spending demands of an ageing population.

   Public sector borrowing and debt

   • Although the Budget outcome is an effective measure of the underlying stance of fiscal policy, it does not represent the full impact of the public sector on the economy
   • The overall impact of the public sector on the economy is reflected in the public sector underlying cash outcome, which shows the borrowing needs or surplus funds from all levels of government, as well as government authorities and public trading enterprises.
   • A rising deficit/smaller surplus would mean greater public sector stimulus to the economy (as G > T), while a falling deficit/rising surplus would mean less stimulus from the public sector (as G < T). A negative outcome means there is an overall public sector deficit.
   • The public sector cash outcome has persistently been in surplus since the late 1990s. This has reduced public sector debt in Australia (although this is also due to the privatisation of government businesses), which peaked at 35% of GDP in 1994-95 and has declined to under 5% in 2004-05.

   * NB public debt (national debt) = the accumulated debt of the government sector, owed both domestically and overseas.

   The current stance of fiscal policy

   Historically, fiscal policy has played a major role in influencing economic growth. Under the Howard government, however, fiscal policy has moved to playing a less active role within the economic policy mix. The Budget's main role in recent years has been to minimise the extent of public borrowings and to implement specific policy changes in targeted areas of the economy. Fiscal policy plays a minor support role while monetary policy plays the major role in economic management.

   In 2005-06, fiscal policy will have a mildly expansionary impact on the Australian economy, with the underlying cash surplus shrinking from 1.1% to 1.0% of GDP. The major stimulus to the economy will come from personal income tax cuts, which will inject $3.1 billion into the economy in 2005-06. In addition, government spending will continue growing at a reasonably strong rate.

   This years' mildly expansionary fiscal policy should see the fiscal outcome remain steady at 0.8% of GDP. The large surpluses of the late 1990s are not expected to return, and the Budget is expected to remain in balance in the coming years.

   The shift towards modest Budget surpluses has been accompanied by an expansion of the public sector, growing to 37% of GDP, which means that the government makes up a bigger percentage of the economy. Australians therefore have a higher tax burden than they did during most of the 1990s.

   The budget outcome in 2005-06 is the result of both cyclical and structural factors:

   • Cyclical changes have had a positive impact on the Budget. Continued economic growth has increased employment and wage levels, contributing a 3.4% increase in personal income tax receipts, while company tax receipts are increasing by 32% over only a two year period (due to souring profits for mining companies as a result of the resources boom), increasing government revenue. Without any spending changes, Australia would have a fiscal surplus of $16.6 billion in 2005-06.
   • Structural factors, however, will almost completely offset the positive impact of cyclical factors on the Budget outcome. Discretionary changes announced in the Budget, such as the large annual income tax cuts and spending measures including the government's Welfare to Work package, will reduce the fiscal surplus by $9.2 billion.

   * In examining the government's current fiscal policy, we must look at the general trends in fiscal policy rather than examining the details of one year's Budget. This is because the government now approaches fiscal policy in the context of its three-year parliamentary term:

   1. First term of Howard government: substantial reductions in spending on government programs.
   2. Second term: rebound in spending and a shift from direct to indirect tax (through introduction of GST).
   3. Third/fourth terms: return to modest Budget surpluses (due to boom in commodity prices and company profits, increasing government revenue).

The impact of recent fiscal policy

• In recent years, the government has not used fiscal policy as a major instrument to achieve economic goals (using monetary policy instead)
• In the early years of the Howard government, the problem of the CAD and low national savings was the main focus of fiscal policy. Arguing that the high CAD was a result of excessive public borrowings and low public savings, the government reduced government spending.
• Since 2000, there has been a change in the government's priorities. Major tax reform in 2000-01 and large tax cuts eliminated the government's surplus, and by 2001-02, the need to stimulate growth moved the Budget back into deficit. Since then, spending increases and tax cuts have ensured that even with strong growth driving up tax revenues there have only been small surpluses.
• Critics have argued that fiscal policy has been increasingly influenced by political factors: by not creating Budget surpluses, they argue, it is harder for other political parties to promise large increases in government spending during election campaigns
• There has been an important change in the longer-term stance of fiscal policy. For many years, the government aimed to achieve fiscal balance over the course of the cycle (deficits during recession years and surpluses during years of higher growth). More recently, the government has argued that if the Budget is in surplus and government debt is low, it should "return money" from those surpluses to taxpayers through tax cuts and transfer payments, reflecting a longer-term policy shift.
• The most important longer-term goal of the 2005-06 Budget is to address the challenges created by the ageing of Australia's population. Over coming decades, this will reduce labour force participation rates and taxation revenues, and simultaneously increase spending (on aged pension payments, health and aged care). In response to these challenges, the 2005-06 Budget introduced measures to shift individuals off welfare payments and into the workforce, as well as introducing a Future Fund for government Budget surpluses and the proceeds from asset sales (which can be used to offset the government's own superannuation liabilities).

Economic growth

• Traditional Keynesian economic theory states that reduced government-spending results in a slow down in economic growth
• However, this does not always hold true: eg. economic growth was strong in the late 1990s despite contractionary fiscal policy.
• This reflected the influence of several other factors, in particular the fact that tighter fiscal policy can actually increase economic growth in the medium term if it helps to lower interest rates, makes domestic funds more easily available for investment and improves business confidence. This is a reversal of the crowding out effect (sometimes called "crowding in").
• Nevertheless, fiscal policy can play an effective short-term role in stimulating growth when overall demand levels are low. Expansionary Budgets in 2000-01 and 2001-02 helped to ward off a deeper slowdown. Since then, fiscal policy has had a very limited impact on economic growth, providing only mild stimulus to the economy.

Unemployment

• Fiscal policy has only limited impact on the level of u/e. The impact of recent fiscal policy changes on u/e is closely related to its impact on growth.
• The brief slowdown of 2000-01 saw u/e rise to 7%, but expansionary fiscal policy helped to curb the rising trend
• Strong growth in the late 1990s and early 2000s contributed to reduced u/e levels, which fell to a 29-year low of 5% in mid-2005
• Moderate growth should contribute to a stable u/e rate of around 5% during 2005-06, but with no new major employment initiatives announced in the 2005-06 Budget, there is more change of u/e rising than falling

Interest rates and investment

• There is a strong relationship between fiscal policy and interest rates: a lower deficit will reduce the public sector demand for funds and thus reduce interest rates, while a higher deficit has the opposite effect
• The loosening of fiscal policy in 2000-01 contributed to the progressive tightening of monetary policy beginning in November 1999
• The mildly expansionary stance of fiscal policy in 2005 was a factor in the RBA's decision to raise interest rates in March 2005

National savings and the CAD

• There is no direct correlation in the short-term between the rising CAD and the current fiscal outcome
• However, by increasing the level of public savings through running surplus Budgets, the government can contribute to a higher level of national savings, which over time should help to reduce the CAD
• This goal has not been a major priority in recent years, with the Budget only just in surplus. Instead, current policy is to ensure that the government is not adding to Australia's savings imbalance by running a deficit Budget.

Income distribution

• The overall effect of the 2005-06 Budget is likely to increase income inequality
• Although some changes, eg. the 2% reduction in the lowest marginal income tax rate (giving lower income earners a larger proportional tax cut), other changes such as the rise in the top two income tax thresholds mean that higher income earners get much larger tax cuts.
• Overall, the changes will make Australia's tax system less progressive
• The Welfare to Work package is also likely to cause an increase in inequality if these individuals do not receive adequate support to find employment