Tax Buoyancy
The Finance Minister recently presented fiscal consolidation projections that surpass expectations for the current financial year and Budget Estimates (BE) for the next year, despite the conservative tax buoyancy in the estimates.
About Tax Buoyancy:
- Tax buoyancy explains the relationship between the changes in the government’s tax revenue growth and the changes in Gross domestic product (GDP).
- There is a strong connection between the government’s tax revenue earnings and economic growth.
- As the economy achieves faster growth, the tax revenue of the government also goes up. Tax buoyancy explains this relationship.
- It refers to the responsiveness of tax revenue growth to changes in GDP.
- When a tax is buoyant, its revenue increases without increasing the tax rate.
- It depends upon:
- the size of the tax base;
- the friendliness of the tax administration;
- the rationality and simplicity of tax rates;
- Tax buoyancy will be highest for direct taxes. Generally, direct taxes are more sensitive to the GDP growth rate.
What is tax elasticity?
- A similar-looking concept is tax elasticity. It refers to changes in tax revenue in response to changes in the tax rate.
- For example, how tax revenue changes if the government reduces corporate income tax from 30 per cent to 25 per cent indicates tax elasticity.
What is the Laffer Curve?
- It is an economic theory pioneered by economist Arthur Laffer.
- Created in 1974, it visually shows the relationship between tax rates and the amount of tax revenue collected by governments.
- It suggests that tax rates above a certain threshold reduce tax revenue since they incentivise people not to work.
- It suggests there is an optimum tax rate which maximises total tax revenue.