Taxes
Tax laws affect taxpayers because they create the taxpayer and govern all aspects of the taxpayer's obligation to the state. Without tax law, there would be no taxpayer; it is the tax laws that create the obligation to pay taxes, and the punishments for non-payment. Tax laws establish who pays taxes, at what rate they pay taxes, the punishments for late or non-payment, and the establish the tax collection body (IRS) and grant that body the authority to run the tax system. Taxation is one of the major ways in which the state can influence behavior in a democratic country. States have long reserved the right to taxation, and the exclusivity of this right has been a feature of government for centuries. Today, there are usually specific rules regarding what layer of government can levy taxes for what purpose. Taxes have different names, too, including excise taxes, income taxes, capital gains taxes, and property taxes. The essential component of any taxation system is that the state has a right to charge a tax of some amount on just about any asset a person owns, acquires or transfers. Taxes are part of the implicit social contract in a society where government uses taxes to provide essential public goods to the people under their jurisdiction.
Once the basic taxation system is established, the body of tax law serves to govern every aspect of taxation. Tax law includes a number of different elements, including the different incentives, deductions and other elements. First, taxable income is defined as the starting point. What sorts of income are subject to taxation, and at what rate, is something that comes from tax law. Governments use tax law to create incentives for specific economic activities. For example, capital gains are taxed at a different rate compared with dividends. That incentivizes companies to pursue growth, which results in capital gains, rather than to seek stability and high dividends. Tax policy is therefore used to advance specific objectives that government has.
This has an impact on taxpayers, because they are ultimately the ones whose actions are subject to taxation incentive. For an individual taxpayer, this is reflected in a number of policies that seek to influence decisions. Where there are tax rebates or other incentives for having children, people may have more children. Being able to write off mortgage interest encourages people to purchase houses, especially when rent is not subject to the same tax benefits....
One area where tax policy has a substantial influence over individual taxpayers is with
respect to retirement. There are a number of incentives for taxpayers to save for retirement. The tax system is set up to allow for certain deductions for retirement savings, and then there are additional tax incentives for employers to contribute as well. The development of the 401k plan, for example, has spurred a growth in retirement savings, but because this usually means investing in the
debt or equity markets, tax policy also had a
significant impact on
monetary policy, influencing where the
money supply was in the
economy.
Tax policy is also a component of the
Affordable Care Act, because there is the
individual mandate where somebody who does not purchase health insurance pays a tax penalty. Again this is an example of using the various carrots and sticks of tax policy to influence individual behavior. For the taxpayer, this creates a fairly complex web of incentives and penalties that can be difficult to navigate. Minimizing one's tax burden relative to one's income has become an art form, as individuals who have a high level of knowledge, or who are willing to pay for expertise, are likely to have better tax outcomes than individuals who do not possess or acquire this knowledge.
Management decisions are likewise influenced by tax policy. One of the most significant categories of
management decisions is
capital structure. Equity and debt are taxed at different rates. Because debt is taxed on a before-tax basis, and equity is subject to double taxation, the cost of equity is higher. This creates incentive to lower the firm's cost of capital through the use of debt. Management has to weigh this against the risks inherent in higher rates of leverage, but ultimately the government is incentivizing leverage to a certain extent through this longstanding tax policy.
Management also makes capital budgeting decisions with taxation in mind. In many cases, states, cities and other sub-national governments use tax incentives to attract business. Locating a factory in a particular city or state might…
