The suggested ways in modern times to balance concerns with efficiency, equity and administrative simplicity and reliability referring to tax systems have evolved considerably. Remarkably, the system of voluntary compliance yields not a very high percentage of tax revenue liabilities actually due, especially when viewed relative to other countries. That speaks not very well of Albanians’ tax system basic values. But there is episodic concern, that the system of voluntary compliance will be decreasingly effective over time and the nation will be driven to transactions taxes unless a strong tax system replaces the current tax system.
According to that concern I have some standards that may be applied to tax reform proposals for my country.
1. Will tax reform improve the performance of the economy?
By far the most important aspect of economic performance is the rate of economic growth because that growth determines future living standards. The most important way the tax system affects economic growth is through the rate of saving, investment, entrepreneurship and human capital investment.
2. Will tax reform affect the size of government?
Tax reforms that more closely tie the payment of taxes to expenditures will promote a more effective and efficient government. A new large broad-based VAT, may just be piled on top of the existing taxes and used to raise revenue to grow government. This is what has happened in many European countries and is a major detriment to their economic performance.
3. Will a new tax structure affect cooperation between local and central tax powers?
Tax reforms can affect the tax system in many ways. Some types of tax reforms would implement taxes heavily relied on by state and local government, e.g. retail sales taxes (or VAT). We should favor those that strengthen central and devolve authority and resources to state and local government and private institutions to the extent possible.
4. Will a new tax structure likely endure?
We have had 5 major tax reforms or fundamental tax reforms in the last two decades, approximately one in every legislature. We should be concerned that we might move to a better tax system only to undo it shortly thereafter. In 1993, the trade-off was lower rates for a broader base. That was slightly undone in 1998, and dramatically so in 2003, whereas in the last three years, rates have been reduced. A more stable tax system would reduce uncertainty and, in its own way, be less complex.
5. Over time, will tax reform contribute to a prosperous, stable democracy?
Are we likely to see a change in the ratio of taxpayers to people receiving income from government? We now have a much higher ratio of people who are net income recipients to people who are taxpayers than in any previous time in our history, reflecting not only transfers but other features of the income tax itself. Fortunately, that number is still well under 50 percent. But as we move through time, as the retired population grows, the baby boom generation and Albanian emigrants abroad approaches retirement and then retires, the fraction of the population in any given year who are receiving more than they are paying will grow. We must deal with this both on the tax side (underground economy, chary of too many off the income tax rolls) and, especially, on the transfer payment side and do so soon, or we will get into a spiral of higher benefits, higher tax rates, a weaker economy, and ever-greater political conflict between taxpayers and transfer recipients.
Key decisions for design tax system
With these standards (questions, we can ask in designing a tax system, what are the major decisions that need to be made?
There are four decisions: the choices of tax base, tax rate(s), the unit of account and the time period of account (see insert). We outlined above why it is important to keep the rate(s) as low as possible to minimize the distortions to the economy.
What about the tax base?
It is generally understood that a pure income tax would tax saving twice: first when it is earned as part of income and again when it earns a return in the form of interest or dividends. An alternative way to think about this is that present consumption is taxed once while future consumption is taxed twice because the bulk of saving is done for the purpose of future consumption, for example, during retirement.
Most fundamental reforms are designed to redress the severe distortion of saving and capital formation caused by the current system of income taxation. Most other countries rely much more heavily on taxes on consumption so-called indirect consumption taxes such as sales taxes and value-added taxes and income tax systems that exempt large amounts of saving from the tax base – thereby leaving most households’ tax base as income minus all saving (i.e., only that part of income that is consumed). Most of their corporate taxes have various features that allow more rapid write-off of investment.
Now consider the separate corporate and personal income tax and a individual putting his saving in corporate equities. The individual first pay taxes on his own income, their consumption plus saving. That is tax one. He save some of that after-tax income in the form of corporate equities. But the corporation pays corporate taxes (on behalf of the family as a shareholder). That is a second tax. Then the individual pays taxes again when it receives dividends or capital gains (in this case one has to net out inflation, deferral, the possibly lower tax rate, incomplete loss offset, and so on to determine the true effective tax rate). That is a third tax on the saving. If the individual is fortunate enough to accumulate over its lifetime enough to leave a taxable estate, the saving may be taxed a fourth time. Of course, there are numerous exceptions to this rule.
The empirical studies developed in last two decades by finance experts, strongly endorses an (explicitly or implicitly) integrated business and personal tax which taxes broad consumption at low rates. There are several approaches to implementing such a system.
What is likely to be gained by moving to one of these tax systems? Will it be worth the substantial political capital and transition costs to various families, firms, industries, and economic disruption that accompany any major tax change? The answer, in my opinion, is that the gains are potentially quite large. Some of these experts estimates long-run gains in consumption of 10% from replacing the current corporate and personal income taxes with a broad-based, direct or indirect tax on consumption or consumed income. This occurs because the increased saving and capital formation increase wages and future income. These are large potential gains, on the order of a decade’s worth of per capita consumption growth.
It is hard to find another policy reform with that large a p