Balancing between Tax Rate and Tax Revenue

Governments around the world have used various forms of taxes to generate revenue of their annual budget which is in return spent of state’s welfare. Larger tax collection would mean bigger budget with the Federal and State governments and they would provide more and better facilities for its citizens. Taxes are often the only source of income government has and it implements various plans to increase its tax collection and encourage people to pay their taxes fairly and on time. There are generally two ways in which revenue collected through tax collection be increased. First by ensuring that all citizens falling under the income tax bracket pay their tax dues genuinely. And secondly by imposes higher tax rates. But does increased tax rates always result in incremental tax revenues? Let us discuss this is detail.

Historical figures in United States have shown a very peculiar trend. Immediately after increase in tax rate the revenue collection is increased but over a little longer time period the trend is reversed the revenue collections goes down. And completely opposite of this whenever tax rates have been cut the revenue collections have gone up in the longer run. Andrew Mellon, Secretary of Treasury in 1920 for the first time demonstrated with evidence that higher tax rates actually result is lesser revenue collection. Many people were discouraged to invest money in business thinking that his share of actually profits will come down due to higher tax rates. Overall business community follows the same trend resulting in lesser income generation and directly effecting tax generation capacity of the nation. At this stage people find alternative ways to invest their money. They either invest their in tax-free securities or tax free bonds, either which ways government begins to lose its source of income.

So Mr. Mellon demonstrated when tax rates were reduced from 70% to 25% it actually resulted in overall increase of 61% in tax revenues. Tax revenues prior to 1920 stood at a level of $719 million while after the tax reforms it raised to $1164 million for year the 1920. Similar method was used by Kennedy regime which helped them to increase revenue collection in excess of 33%.

It is also worthwhile to mention here that increased revenue collection by government encourages it to spend more and commit itself to more expensive schemes and projects. More often than not government over stretches it while spending and is need to more money is short span of time. This urgent requirement of money in short time could only be met by increasing the tax rates. So this circle goes on and on.



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