The lmpact of lags in Tax Collection During the Case of Fiscal Drag - A Note

The lmpact of lags in Tax Collection During

the Case of Fiscal Drag - A Note (*)

Ar. Grv. Hurşit GÜNEŞ Marmara Ünivers'itesi İktisadi ve İdari Bilimler Fakültesi

High rates of inflation in the tost decade have caused many tax-payer~ to complain about the unnecessary promotion of their tax-brackets, even when their ·gross incomes or ta.x-bases have not c~a.nged in real terms.

One solution popularly argued has been the revision of tax -brac.kets and tax-bases to avoid the receipt of unfair tax revenues by the Treasury due to a fiscal dmg (1). in other words, the govern-ment must either reduce the· tax-base in a way index-linked to inf-lation or revise the tax brackets frequently. This, although contra-dicts with the desire of the 1government to reduce budget deficits

during (2

), it is acceptable on the grounds of equity and fairness.

Here, we shall attempt to demonstrate that the ta.x-payer does not lose in all disequilibrium markets of general price levels, but only in inflation when the level mal interest rates is very low or negative, or the promoted tax-bracket is a lot higher than the prior one. lf there is any relationship between the level interest rates and price· levels, then surely the effects of those form·er changes should be taken into account. in other words, it can be argued that as the private and corporate tax-payers who are not generally fixed-salary earners pay their taxes at a particular date of the fiscal annum,

(*) 1 am indebted ·to Professors Sir Bryan Hopkin and Vural Savaş, and David Williams for reading this note and commenting on it. My thanks ere also due _to Sudi Apa1k as by one reminder only, a rewriting of the article was

neces-sitated. Any remaining erros are my reısponsibility.

(1) in United States economiısts prefer the term "tax-creap' instead of·

'fiscal drag'.

(2 ) Progressive taxation during inflations beoome automatic fiscal stabiHzers

or long after the financial accounts for that year are closed, they may use their tax-'bases and earn some yield on it until the tax is

collected. Below the algebraic formulations and the example show

that the real interest rates must be quite high for the avoidance

of tax-payers unnecassary losses. it should again be reiterated that · in disequilibrium markets, interest rates gain volatility and this should also be taken into account.

in deflations, the tax-collector. (or receiver) becomes the net loser, and the ta.x-payer not only gains interest (3), but also by paying

less taxes undeserverdly. in deflations, as prices are declining real rates of interest ascend and the tax-payer can receive a large yield on his tax-base until he pays his tax. At the same time, as his tax-base is appreciated (it revalues spontaneously), he pays less taxes.

Lut us show; ·

P as the percentage rate of inflation

( =

dpe_)

Pi as the rate of inflation on the i'th doy (i

=

1,2,. .... ., k) ·

Pa as the rate of inflation calculated from the retail price index.

The tax-payer loses real income by inflation via the diminishing

purchasing 'power of disposable income.

P~ as the deflator Which is calculated over other price indexes

as the government spends both on capital and consumer goods.

Thus,

Pai

is the rate of consumer price inflation on daily basis, and

P~i is the rate of general price inflation on daily basis. in other words, o fixed rate of inflation is not assumed

Ynı is the pre-tax nominal gross income earned in previous year, in other words it is the nominal tax-base.

Yrı is the real ta:x-base deflated by

Pai.

(3) Although prrces decline in ·deflation. they never become negative. lnterest is alsa a price and ·they also decline but never become negative nominal terms. 222

Yri

=

Yni

:+

(Yni · Poei)

Tj is the percentage tax-rate applied progressively on nominal

incomes, in other words it is the tax-bracket. T n -is the nominal ta.x receipt

Tr is the real tax revenues, and

7t is the post-ta.x real loss or gain of the tax-payer.

Note that THı

>

Tj in deflation, and if 1t

>

O the tax-payer gains and tax-payer lose,s.

r is the nominal rate of interest, and i is the reaı interest rate, simply derived f rom, i

=

r- P

The generally argued excess ta.x can be formulated as belo~ :

[t2-tı] {Ynı-+- (Ynı (Poeı)k-l)}

+

{Yn2-+- (Yn2. (Poe2)k-2 )}

+ •••••• +

{Ynk-+- (Poek)k-l} Note that, Ynk (Poek)

=

Ynk as tf;0

₌

₁

On the other hand the ta.x~payer will have interest gains due

to lags in ta.x-collections as;

(,~

v.,

(1

+r,•-•ı

)-(

(H,)

;~ı

v.,(1

+P.,•-•ı)

='it if n

>

O, ta.x-payer has a net gain

if. n

<

O, the ta.x-payer has a net loss

Below, an example is given from the Turkish economy where the

monthly incomes of a tax-payer are· not fixed. The example

assu-mesthat in the first three months, the real ta.x-base is about 10 per-cent more than the second quarter; the ta.x-base of the second quarter in real terms is about 1 O per cent higher than the third and so on. in other words, in the first halt of the year the tax-base in

real terms is more than 20 percent higher than the second half.

As seen on Colum 1 of Table 1, the nominal ta.x-base is- taken

on a monthly basis (Yn1) ... P~ı is the monthly rate of inflation and

. assumed to be fixed to 4 per cent per month. The Turkish tax ıaws

if the tax-base is higher than 1 million TL but less than 3 million TL., the amount in excess of 1 million TL is ta.xed at a rate of 30 per cent.

. The conventional argument is that, during inflationary periods it İS possibJe for a tax-payer to pay higher taxes, even-when inceme is constant or falling in real terms, due to the progressive nature of taxation system. · ın mest underdeveloped countries where the economy is predominantly agricultural and ,tax collection is costly, taxes are not collected at the source of incornes. Yet, Turkey although a less developed country, is no more a predominantly agricultural country and the state of its level of development is not comparable to many LDCs. Appreciably the time has come for the change of tax-collection system in the case of Turkey. lncome taxes in Turkey are declared three months after the financ.ial term is closed, and they are paid in three im~talments from this date., the second in-stalment by the sixth month and the last by the nineth month.

in our e.xample, the ta.x-base is 2,370,000 TL and the total re-quired tax is 661,000 TL. As explained above, the conventional complaint is that by the date of tax-declaration, tax bases are in-flated and they are unjustİfiebly promoted to higher tax-brackets. To demonstrate this argument, tax-bases are deflated on Column 111, and we achieved a total of 1,633,690 TL. According to this tax-base, the ta.x-payer should pay 449, 107 TL of total taxes and thus he has a net loss of 211,893 TL. .

Lags in tax-collection has another facet too. These lags can be measured by the opportunity cost of money to businessmen; the rate of interest on credits. in the example above on Table 1, a fixed rate of interest throug'hout the year of 5 per cent a. month, and a constant rate of inflation, 4 per cent a month is assumed. On Column VI, Y niTi represents the amount of income taxes being saved instead of paying instantenously with the earning of income. As it İS seen on Column Vll, these taxes with interest yields add up to 1,039,422 TL until the first instalment of tax-payments.

Each instalment is 220,333 TL, and the tax-payer will possess 819,089 TL after the first payment. Until the sec.ond payment,

tor

three months, the tax-payer ·can use this money and earn some yield of 129,416 TL. Thus, he will 'have 948,505 TL at his dispotal but pay another 220,330 TL as a final ta.x-paymet. Hence, his de jure and de facto delay of tax-payments give him a ta.tal ·gain of 728, 172

TL. This gain is almost 3.4 times higher than the loss due to fiscal drag. lf on the other hand, the· collection of taxes are held at source (see the last column on Table· 1) a total of 508,391 TL would be paid. This method woutd to a large extent avoid fiscal drag, and the· loss to the Treasury caused by the lag of payments.

As seen on Table 1. A below, the final conclusion for the

tax-ıoss of the· .government should be reflected in realvalues. The first column below shows the nominal interest yield until the third month after the financial year. in other words, these are the corresponding interest yield values from unpaid taxes until the first tax-payment. The second column the taxes saved pılus the interest yield in real terms.

1\) 1\)

O) _{TABLE 1: LAGS iN INCOME TAXES}

Nominal Whole-Sale Real Real Nominal Raid Taxes Saved Taxes lterest Rate Simultaneous

Tax-Base Price Tax-Base Tax-Base Tax-Base Plus For Credlts Taxes

Defla;tor lnterest Yield

Ynı Pcxı ; Yri {Yr1>2 Ynl+rl Ynı X T1 {Yn1XT;)+r1 r,

(Yr1) 2 X T; 240.000 1.801

f+>

133.260 149.906 (

+)

498.960 60.000 124.740 2.010

c+

::ı:> 37.477 120.000 1.732 69.284 77.973 237.600 30.000 59.400 1.980 19.493 150.000 1.665 90.090 107.531 282.900 37.500 70.725 1.886 25.383 180.000 1.601 112.430 126.493 323.280 4§.000 80.820 1.700· 31.623 210.000 1.539 136.452 153.397 359.100 52.500 89.775 1.710 38.349 170.00(} 1.480 114.865 - 129.179 276·.930 46.000 74.934 1.629 32.235 190.000 1.423 133.521 150.198 294.690 57.000 88.407 1.551 37.550 370.000 1.369 270.270 304.026 546.490 111.000 163.947 1.477 85.642 60.000 1.316· 45.593 51.282 84.420 18.000 25.326 1.407 15.385 '' 270.000 ' 1.265 213.439 240.000 361.800 81.000 108.540 1.340 72.000 180.000 1.217 147.905 166.359 229.680 54.000 68.904 1.276 49.908 230.000 1.170 196.581 211.154 -158.080 69.000 83.904 1.216 63.346

---2.370.000 1.663.690 1.867.498 3.762.960 661.000 1.039.422 508.391

r:p and

c+ +>

are tor 15 months. ( +) _defiatecı tor 12 months.

TABLE 1 A

il 111 ıv

(Y niTJrı) - (V nıT;) YnıT;rı _pi (Y nıT{ı>

+

(Y nıT;) YriTi pi 64,740 35,947 69,262 33,315 29,400 16,975 34,296 17,321 33,225 19,9Ş5 . 42,477 25,522 35,820 22,374 50,481 28,107 37,275 24,220 58,333 34, 113. 28,934 19,550 54,009 31,081 31,407 22,071 62,127 40,056 52,947 38,676 119,757 81,081 7,326 5,567 19.245 13,678 27,540 21,771 85,802 64,032 14,904 12,247 56,608 44,371 14,904 12,738 77,713 58,974 381,422 252,091 724,120 471,651

Until the 15 th month real tax-base with interest

yield ···•••u•···~····. 724, 120 less one third of tax {real tax base at the 15 th

month without interest yield} .. . . .. ... .. ... .. ... 157,217

566,903

plus 3 months interest of ... ~... 89,358

656,261 in deflated terms tor 3: months ... ~... 583,343

less the second tax payment depreciated far

3 months . . . .. . . .. . . • . .. . . .. . . 139,749

plus 3 months interest of

443,594

69,921

in deflated terms for 3 months 456,458 less the tax-payment depreciated for another

3 months ... 124,221

OVER THE TAXES THE TAX-PAYER STILL AT

HiS DISPOTAL ... 332,237 TL The Case of Corporate Taıxes, :

A similar case also exist for corporate tcixes. Nevertheless. in

this case, our argumen.t is far stronger as there cannot be a p·

heno-menon of fiscal drag in proportional taxatiün systems (in Turkey corporate taxes are 40 per cent on all tax-bases). These nominal

tax-bases on the first Column of .Table il, have. their corresponding

taxes on Column il, whiçh adds up to 948,000 TL.. The first instaı .. ment of the tax is paid by the sixteenth month, (or four mon.ths by the en.d of the previous finansial annum), and therefore on Column iV, each corporate tax is being yie·lded with its corresponding inte-rest yield in compound form. As can be seen below, it adds up to 1,585,723 TL.

TABLE 11 - THE CASE OF CORPORATE TAXES

Nom:inal Taxes a.fter

·Corporate Corporate Ra.te of lntere'st Rate of Real Value

Tax-base Taxes lnterest Yleld lnflation of TaMes

(Ynı> (Tı) (rı> (Ynı-Tı)ri (P~ı) (Tı/P~ı) 240,000 96,000 2.183 209,568 1.873 51,255 120,000 48,000 2.079 99,792 1.801 27,714 150,000 60,000 1.980 118,800 1.732 36,036, 180,000 72,000 1.886 135,792 1.665 44,972 210,000 84,000 1.796 150,864 1.601 54,581 170,000 68,000 1.710 116,280 1.539 45,946 190,000 76·,000 1.629 123,804 1.480 53',408 370,000 148,000 1.551 229,548 1.423 108,108 60,000 24,000 1.477 35,448 1.369 18,237 270,000 108,000 1.407 151,955 1.316 85,375 180,000 72,000 1.340 96,480 1.265 59,16·2 230,000 92,000 1.276 1.17,392 1.217 78,632 2,370,000 948,000 1,585,723 663,426 (*) for .1.6 months. 228

When the taxes after interest yield is deflated until the sixteenth month ... .

less the first tax-paymet in real terms ... .

plus six months interest

in deflated terms ... .

less the second tax-payment in real terms ... .

THE FiNAL POSITION

1,046,281 374,615 671,666 218,153 889,719 703,168 296,068 407,100 TL'

. The above position shows us that the tax-payer has: a net gain

in real terms of 407,100 TL. which is on the other handa direct loss of government's revenue. lf c.orporate taxed had been paid instante-ously with the earning, the case would be that 'he would pay

. 663,426 TL.

Conslusion :

in economic literature, inceme .taxes are described as

auto-matic stabilizers if the dominant nature of the taxation system is progresşive. in other words, when inflation prevails, due to promoted

tax brackets, more taxes are collected (4

) which draws additional

money from the economy and less tax during recessions. This

spontaneous stabilization nature of inceme taxes is. partly offset by

long lags in tax-payments.

One of the main injustices of the Turkish Tax S:ystem is that the

niajority of taxes are paid by salary and wage earners. More than

three fifths of the income taxes are paid by this category of

tax-payers whom it is well-known to fall into the lower income groups.

lf budget deficits are caused by deficient taxation (5

) a formidable

and ready way is to reconstruc.t the tax system. in 1983, the budget

. deficit was 8.6 per cent of total Budget Revenues. Wage and salary

(4) Nevertheless fiscal drag would halt to detriment the position of the

tax-payer with the promotion of majority of tax-tax-payers to the last tax-braoket. Thus if tax 1_{brackets ere not revised, the built-in stabilization nature o.f progress·ive} taxes wo-uld cease to exıst after o cer,tain period.

(5) in Turkey as the government exp·enditure is really low, the· o·rily rema1ining cause of budget deficits can be deficient taxation.

earners paid almost 70 per cent of income taxes and those on dec-larations paid about 30 percent. in our e.xample it is seen that the government attains real taxes of 421, 187 TL., 'from the real tax-base

of 1,663,690 TL. The pay - as -·you - earn (PAYE} system would

en-able the Ministry of finance_ to increase its taxes_ to 508,391 TL.

Furthermore, the loss from the delay in tax-achievement (interest yield of the tax-payer} would provide the government with another 411,370 TL. 'Hence, the PAYE system would realize a 118 per cent

increase of income tax revenues on declarations. lf the PA.YE system

is enacted, the Budget revenues can increase by 19.7 per cent which

also enables the. Budget deficit to fail from 7.9 per c.ent of Budget

Expenditures to a surplus of 10.3 per cent of 'Budget Expenditures.

Thus, the unfair share of fixed-income earners in the budget rnvenues would also fail.

in the analysis above, the opportunity cost'of money is measured by the popular yardstick of real interest rate. Again the ready imle-mentation of monetarist policies by raising interest rates fortifies our arguments. The elasticities of taxes and fiscal drag effects of

previous fiscal/financial years are omitted. lntuitively, despite the

absence of a tax-rate change, the tax revenues might not increa~e

to its ·ful! extent..

in short, one would expect legislation to be enacted and to introduce popular PAYE (pay - as - you - earn) system of Britain. This is not as difficult as it could have been twenty years ago because of the popularization automated information systems. The only cri-ticism to PAYE system can be that it involves incremental transac-tions and administrative costs. Nevertheless, with the use of com-puter systems these costs can be minimized.

The mest covenient PAYE system is that each subject of tax-base should be taken at its source after being deflated with respect to the previous subject. Progressive tax-system can stil! be imple-mented by this method as, until the second tax-band is reached by aggregation, ali tax-bases could be taxed at a higher tax-bracket ete. With these changes, the automatic stabilization property of inceme taxes will be fortified.

Appendix The Case for the Agricultural Sector Tax-payers on

Dec.larations - another example: 230

lf a wheat producer is assumed to sell his crops by September and cashs the vqlue of his products, he is allowed to pay income taxes in three installments, the first one is in October and the second

one is the following month; and the last one· is in December of the

following financial year. Let us imagine. that this farmer declares

o tax-base of 2,000,~00TL. tor his income taxes. He is supposed to

pay a total of 550,000 TL. in three instalments. By the thirteenth

month (which is the month tor the payment of the first instalment)

the tax becomes 880,50 TL. with interest yield. Then pays the

second instalment after

a

months interest.

550,000

By the 12 th month (*) ... ... ... ... .... 880,550

'By the 13 th month .. . . .. . . . .. .. .. . . .. .. . . .. . . .. . . 915.,772

less the first tax-payment ("*) ... 183',333

732,439 By the 14 th month .. . . .. . . ... . . 761,737 less the second tax-payment . . . .. . . .. .. . .. . . 16·9;,502

By the 15 th month ... .

less the final tax-payment ... .

592,235

6·15,924

162',983

452,941 TL.

Finally, t~e last instalment is paid after another months interest

yield. When alt the taxes are paid there stili is an amount of 452,941 TL. in the hands of the agricultural tax-payer in real terms.

(*) We assume that the agricultural tax-payer does not indulge in any activUy of investment (as· the credit rate is really low for this ·sector) and he puts this money for making interest from bank time deposits.