Arguments against Tax Competition
February 12, 2025
For any startup financing to be successful, the startup company and the investors need to be on the same page about a lot of issues. This is because, in the absence of this understanding, valuation divergence can be a quagmire of ever-escalating tensions between the two parties. One major source of conflict between these two […]
We are now aware of the various models that are used for equity valuation like Gordon model, H model, 2 stage model etc. in each of these models, we were assuming that the given inputs are dividend, dividend growth rates and time horizon, The output that we expected from these models was the current stock […]
The gender gap in pension systems around the world is a very real and pressing issue. Numerous studies have been conducted on this matter and almost all of them have concluded that the gender gap is a systematic problem that needs to be addressed by pension funds as well as by pension fund regulators across […]
In the previous article, we have already studied about option pools. We now know the various advantages that they offer and why they are preferred by startup companies as a means to compensate their employees. However, some companies and investors are not happy with the concept of stock option pools. This is because they dilute […]
The concepts of cash burn and cash burn rate are relatively new to the investor as well as to the entrepreneur committee. Hence, even though investors have gradually started accepting cash burn to be a normal part of setting up certain types of businesses, they are not really aware of how it needs to be […]
In the previous article, we have studied the concepts of the tax base and tax rate individually. Now, it is time to see how the two react. We already know the basics to some extent. We know that the tax base and the tax rate move in opposite directions. Hence, ideally, if we increase the tax rate, the tax base will decrease, and vice versa.
In this article, we will have a closer look at this relationship and move on to the concept of elasticity of taxes.
Decisions regarding corporate tax policy are made based on this relationship. The degree to which the increase in the tax rate causes a change in the tax base is called the elasticity of taxes. The concept of elasticity is very old in economics. It has been prevalent right since the time of Adam Smith when the principles of elasticity of demand were discussed.
However, when it comes to taxation, elasticity was not paid much attention to. In taxation, economics elasticity is a very recent phenomenon. However, it is quite important for a government that is looking to maximize tax revenues. We can classify taxes into three different types based on the elasticity.
Inelastic Taxes: These are taxes where a change in the tax rate has little or no effect on the tax base. Taxes levied on sin goods such as cigarettes and liquor generally fall in this category. Since the demand for these products remains more or less unchanged, increasing the tax rate leads to an increase in the tax revenue.
Unitary Elastic Taxes: These types of taxes are just theoretical constructs. They do not actually exist. As per the theory, the percentage change in the tax rate is exactly offset by the percentage change in the tax base. Hence, a 10% increment in the tax rate will cause a 10% decrease in the tax base. Since the tax revenue is the product of tax rate and tax base, it remains unchanged. The increase in one is exactly offset by the decrease in the other.
Elastic Taxes: Elastic taxes move in the opposite direction. Here increasing the tax rate lead to a decrease in the tax base. However, the percentage of both may vary. For instance, a 5% increase in the tax rate could lead to a 10% decrease in the tax base. Other times, a 10% increase in the tax rate could lead to a 2% decrease in the tax base. In such situations, raising taxes would be beneficial for the organization.
The relationship between tax elasticity has been extensively studied in recent years. Many generalizations have been drawn in recent years. Some of them have been mentioned below:
The concept of elasticity of taxes has taken a long time to penetrate into economic literature because of the following reasons.
The bottom line is that the concept of tax elasticity is very important. Very often, there are political debates in countries that have high debt. In such debates, the idea of raising the tax is often floated in order to increase revenue. However, now since we know about the elasticity of taxes, we know that raising taxes can sometimes lead to a fall in revenue as well.
Your email address will not be published. Required fields are marked *