Impact of Income Tax on Real Disposable Income During Inflation
Drawing attention to the after-tax income, or disposable income (D), one may say that the marginal rate of increase
where g denotes the rate of increase in income
(1) If we could assume that the tax elasticity (є) is equal to unity, i.e., the tax is assumed to have a single flat rate, then the ratio (ξ) would take a constant value (unity). In other words, real disposable income will not be affected by inflation whether the taxpayer belongs to upper income groups or lower ones.
(2) If we assume that the tax elasticity (є) takes the same value (other than unity) for every taxpayer, the ratio (ξ) will have a variety of values depending on the average effective tax rate for each taxpayer—the smaller (ξ) for high-income groups and the higher (ξ) for low-income groups.
(3) Under any actual tax schedule, the tax elasticity, as we observed above, is greater for low-income groups and smaller for high-income ones. This characteristic feature of the progressive tax schedule lends force to hold the ratio (ξ) down for the low-income groups. Thus, whether the value of the ratio (ξ) is favorable for low-income groups or for high-income groups depends solely on which of the two factors [the average effective tax rate for each taxpayer factor
Mr. Hirao, economist in the Fiscal Affairs Department, is a graduate of the Kyoto University. He was formerly a member of the staff of the Tax Bureau in the Japanese Ministry of Finance.
Mr. Aguirre, Tax Administration Analyst in the Fiscal Affairs Department, is a graduate of the University of the Republic of Uruguay. He was formerly a member of the staff of the Income Tax Agency in the Uruguayan Ministry of Finance.
A taxpayer will pay, on average, an increased tax liability—45 per cent more than that in the previous year—in money that has 30 per cent less purchasing power; that is, he has to pay a tax that is higher by 11.5 per cent, in real value
Teruo Hirao, “Factors Affecting Elasticity of Personal Income Tax—A Case Study of Japan” (unpublished paper, June 1968), pp. 6, 7, 26, and 27.
Oscar Oszlak, “Inflation and Income Tax in Argentina” (unpublished paper submitted in April 1965 to the Seminar of the International Program in Taxation, Harvard University Law School), pp. 39—42. Table 2 of this paper shows a slight modification of Oszlak’s example.
The Tokyo retail price index, converted to a 1950 base year, was as follows:
The fiscal year in Japan runs from April 1 to March 31.
National Tax Administration Agency, Annual Report for Fiscal Years 1949, 1950, and 1951, October 1952, p. 431.
A similar observation was made by Professor Hinrichs on the Argentine tax collections. “During the past 6 years the fall in the ratio of money supply to GNP from 37 percent to 18 percent has aggravated the public finance dilemma. The other determinants already mentioned were serious problems already but the diminution in the means of tax payment undercut much of the tax collection system. Evasion has always been a serious problem in Argentina as elsewhere throughout Latin America. But the shortage of finance contributed to nearly half the deficit in 1964 being due to unpaid but acknowledged back taxes.” See Harley H. Hinrichs, “Lessons of the Argentine Revenue Sharing Experience,” in Revenue Sharing and Its Alternatives: What Future for Fiscal Federalism? (prepared for the Subcommittee on Fiscal Policy of the Joint Economic Committee of the U.S. Congress, 90th Congress, 1st Session, Washington, July 1967), pp. 571–72.
Report on Japanese Taxation by the Shoup Mission (General Headquarters, Supreme Commander for the Allied Powers, Tokyo, 1949), Vol. II, p. 217; hereafter cited as the Shoup Mission Report.
E.J. Mishan and L.A. Dicks-Mireaux, “Progressive Taxation in an Inflationary Economy,” The American Economic Review, Vol. XLVIII (September 1958), p. 591.
For example, see Oszlak, op, cit.
Oszlak, op. cit., pp. 31–35.
See pp. 289–304.
See Hirao, op. cit., p. 27. Tax cuts can be made by widening income brackets according to the price indices.
In the period of inflation (1947–50) it was fixed on January 31.
“Year of assessment” represents the Income Tax Department’s accounting year and covers a period of 12 months from April 1 to March 31.
In the United Kingdom itself, tax charged on any individual engaged in a trade or profession is payable in two equal installments, the first on January 1 in the year of assessment (which runs from April 6 of one year through April 5 of the following year), and the second on the following July 1. The tax is assessed on the income earned in the taxpayer’s accounting year ending in the preceding year of assessment. Thus the first payment is delayed between 9 and 20 months and the second between 15 and 26 months, from the closing day of an accounting year.
According to the Shoup Mission Report (Vol. IV, pp. D41 and D42), “The present income tax picture is marked by a very high delinquency rate as respects tax payments. As of 31 May 1949, the tax collections with respect to individual self-assessed income taxpayers for the taxable year 1948 were about ￥ 107,700,000,000 with a delinquency of approximately ￥ 35,183,000,000. In addition ￥ 6,570,000,000 was delinquent as respect 1947 taxes. The number of delinquent accounts was about 3½ million.
“Such a delinquency situation is very serious. Proper tax administration cannot tolerate such a heavy load of unpaid taxes. Stern efforts are necessary to reduce these delinquencies immediately. It is estimated that a considerable percentage of the delinquent taxpayers could pay if proper and effective measures to enforce payment were taken. In other cases the delinquent taxes will be found to have been improperly reassessed. Tax Office personnel should be made immediately available to work on this matter and a persistent drive made to collect the unpaid taxes and to reduce the delinquencies to a reasonable level.”
National Taxation Offices carry out, except in special instances, all the field services, such as assessment and collection of national tax.
The whole territory is divided into ten districts, each of which has a National Tax Administration Bureau. It exercises, under the superintendence of the National Tax Administration Agency, the direct guidance and control over the National Taxation Offices situated in the district. Besides, the Bureau handles directly the assessment and collection of taxes for certain taxpayers.
When a taxpayer fails to pay tax in full by the due date, the Chief of the National Taxation Office sends a notice of demand after the time limit. If the taxpayer has not paid the tax due within ten days after the notice of demand, the tax authority initiates a distraint.
The estimate of tax yield of the self-assessed income tax for the 1949 fiscal year was ￥ 170 billion and the tax actually collected was ￥137 billion; for the 1950 fiscal year, ￥ 117 billion was estimated and ￥ 93 billion collected.
When three years had elapsed with no significant changes in the taxpayer’s condition after the enforcement had been suspended, the tax liability was canceled.
Interest is sometimes charged on the period covering a statutory extension of payment, but this is not properly considered a sanction against tax delinquency.
Interest runs for the period of postponement at the rate of 2 sen per diem for 100 yen (7.3 per cent per annum) under normal circumstances. In times of tight money, the rate may be raised according to a formula linking it with the prime rate. Interest is deductible as a necessary expense in computing taxable income.
The tax authority may, at his discretion, exempt a part or all of this late payment penalty for the period of extension of payment in unusual circumstances, e.g., the taxpayer is allowed to postpone the tax payment if he suffered disaster from earthquake, flood, or fire and cannot make prompt payment.
A notice of assessment is issued when the taxpayer either fails to file a return or underreports tax.
Tokyo retail price indices rose by 169 per cent in 1947, 193 per cent in 1948, and 63 per cent in 1949.
Shoup Mission Report, Vol. II, p. 222.
International Monetary Fund, International Financial Statistics, November 1969.
It was 12 per cent a year in 1969.
Tax payment is considered voluntary if it is made before any collection proceedings have been initiated or within 10 days after the tax becomes due, even if such proceedings have been started.
By statutory interpretation, such surcharges are in the nature of an indemnification of the Treasury rather than delay penalties (Income Tax Law, Art. 22).
The Model Tax Code was prepared by three Latin American tax experts at the request of the Joint Tax Program. It was drafted after extensive consultation with other Latin American tax experts and published in 1967. Reforma Tributaria para América Latina, Vol. III, “Modelo de Código Tributario” (Programa Conjunto de Tributación OEA/BID, Unión Panamericana, Washington, 1967).
As discussed later (pp. 297–98), late payment charges should not be deducted as an expense. Therefore, comparison with the current market rate should be made in terms of their effective rates.
This interest charge refers to the charge that is a part of fiscal sanctions against taxpayers in arrears. The interest running for the period of statutory extension of tax payment should be deductible as an expense, because it is not a delay penalty but interest in the ordinary sense.
For Argentina, Professor Hinrichs observed, “During and following the period of recession, political turmoil, and uncertainty in 1962–63, much of the energy of the tax administration was shifted to arranging financial payment plans for tardy taxpayers (some payments were scheduled up to 1970) rather than in a rigorous collection of tax revenues. There has been little recourse to prosecution of tax nonpayment or outright evasion. Companies and individuals have been given financing, discounts, and/or concessions in hope of future payment rather than meaningful penalties; bankruptcy and prosecution have not been used as instruments of enforcement.” (Hinrichs, op. cit., p. 571.)
See the following subsection.
Alan Page Murray, British and American Systems of Income Tax Withholding (unpublished doctoral dissertation, Columbia University, 1961), p. 1.
The corresponding figures are approximately 73 per cent in 1968 for the United States and about 87 per cent in 1966–67 for the United Kingdom.
The term “current withholding system” is more appropriate than “withholding system” because the latter does not include the principle of current payment; in Singapore, for example, the employer is required to withhold tax in discharge of employees’ tax liabilities calculated on income of the preceding year.
The term “pay-as-you-earn (PAYE)” is not used in this paper because its meaning became vague as the system was adopted in different countries.
Murray, op. cit., pp. 51–85.
George E. Lent, “Collection of the Personal Income Tax at the Source,” The Journal of Political Economy, Vol. L (1942), p. 725. See also United Nations Department of Economic and Social Affairs, Manual of Income Tax Administration (Discussion Draft, New York, 1967).
In some countries discrimination against taxpayers subject to withholding is even more serious because the tax withheld becomes the final liability and the system is not designed with any cumulative feature. Where it provides for progressive rates, it is heavily weighed against taxpayers that have fluctuating income and/or seasonal employment.
In Argentina imprisonment from one month to six years may be imposed upon those who incur such a violation, combined with a fine ranging between one and ten times the tax withheld. The Brazilian tax law explicitly defines this violation as equivalent to the crime of misappropriation, which is also sanctioned with imprisonment according to the Penal Code.
See pp. 277–80.
See pp. 283–88.
However, experience has shown that a sharp increase in tax delinquency and an expansion of taxes in arrears almost always follow a severe inflation. There are grave doubts that the government would be capable of collecting in full the taxes for the preceding year, regardless of the collection method used.
However, if withholding covers small savers, the need to speed up refunds will pose an administrative problem.
This would not be true if income taxes from corporations were considered fully, particularly in countries where the corporate sector plays a dominant role.
Before the introduction of its present prepayment system, Japan adopted a declaration-of-estimated-tax system that lasted for only three years. Taxpayers were required to file a declaration of estimated tax for the current year and at the same time to file a return determining the final liability of the preceding year. Two thirds of the estimated tax was to be paid within the current year. The result was described as follows: “In practice, however, taxpayers in their declarations generally estimate their income far below the actual amount. As a consequence, tax collections during the year fall well below these one-third and two-third levels. Collections then rise sharply at the beginning of the next year, under the pressure of reassessments. The pay-as-you-go system is thus defeated and tax collections are completely unbalanced.” (Shoup Mission Report, Vol. IV, p. D7.)
Also, Oszlak notes: “Nevertheless, advanced payments are often delayed or simply omitted, since in most cases no penalties are applied once the final return is submitted.” (Oszlak, op. cit., p. 25.)
This will probably take the form of forgiving the previous year’s tax. Another solution would be to forgive all or part of the taxes for the year in which the tax is the lower.
Annual Report of the Secretary of the Treasury on the State of the Finances for the Fiscal Year Ended June 30, 1943 (Washington, 1944), p. 107.
Ibid., p. 111. “… the act canceled 100 percent of the lower of the tax liabilities for the years 1942 and 1943 where that liability was $50 or less, a percentage somewhat lower than 100 percent but greater than 75 percent, where the liability for the lower year was between $50 and $66.67, and 75 percent where the liability for the lower year exceeded $66.67. In certain cases where the taxpayer had a surtax net income for both 1942 and 1943 exceeding by more than $20,000 his surtax net income for the highest of the base years selected by him, 1937 to 1940, inclusive, a smaller percentage of the lower year’s liability was canceled. … the act provided that the uncanceled 25 percent could be paid one-half March 15, 1944, and one-half March 15, 1945.”
Beginning in 1951 corporations were to speed up payments gradually over a five-year period until they were on a two-installment basis with payments on March 15 and June 15 of the following year. The transition was to be accomplished by reducing the tax paid in the third and fourth quarters by 5 per cent of the total tax liability each year, and increasing correspondingly the tax paid in the first and second quarters.
In 1955 a start was made in moving toward payments in the current taxable year by requiring corporations with income in excess of $ 100,000 to estimate their taxable income for the year and to make advance payments in September and December. During a transition period of five years each of these advance payments was to be made at 5 per cent of the current tax due for the entire year beginning in 1955 and rising by 5 per cent a year to 25 per cent in 1959 and later years.
Further acceleration of current payment started in 1964 and continued over a five-year transition period. During this period about 10 per cent of the tax was paid in addition to the normal level of tax payments.
The tax collectors are to be appointed from the following: (1) buyers, for purchases of agricultural, forestry, mining, and fishery products and handicrafts for export and interinsular commerce from producers, produce merchants, and wholesalers; (2) sellers, for sales of industrial products, handicrafts, agricultural products from interinsular trade, and estate products meant for domestic consumption to wholesalers, retailers, and consumers; (3) persons who provide services, for services rendered; (4) the Foreign Exchange Bank, for importers and exporters; and (5) government agencies, if the other party is not such an agency.
The prevailing rate scale is as follows:
|Category||Percentage or Rate|
|Sale of cigarettes by manufacturers to wholesalers||0.5|
|Hire of films||3|
|Exports||Rp 5 per US$1|
|Kerosene and diesel fuel||0.4|
|Category||Percentage or Rate|
|Sale of cigarettes by manufacturers to wholesalers||0.5|
|Hire of films||3|
|Exports||Rp 5 per US$1|
|Kerosene and diesel fuel||0.4|
The prevailing rate scale includes two general rates—1 per cent for goods and 10 per cent for services—and a variety of special rates according to type of business, ranging from 0.2 per cent for gasoline stations to 5 per cent for banks in the main cities.
This is the calendar year for the income tax and the accounting year for the corporation tax.