Why Taxation Is Important in Economic Development?

Taxation is a legal term for the manner in which a country, usually a country’s government, imposes or levies a financial obligation upon its citizens or residents as payment for governmental services or programs. Although taxation may be a verb or a noun, it’s usually most often described as an actual action; the resulting revenues are then usually termed “profits.” There are various levels of taxation depending upon the government’s objectives and goals. Rates of taxation vary from the minimal tax that prevails on domestic level matters, like income and corporate profits, to the highest rate of taxation commonly seen on foreign trade.

 

Developing nations issues differ on taxation because of differences in local culture, tradition and practices, and needs. In countries that lack a stable government system, local officials, particularly the poor ones, struggle to understand and follow tax policies. Consequently, effective and well-developed tax systems in developing countries are unable to curb corruption and other illegal practices. On the other hand, developing countries also face substantial problems relating to tax burdens. Taxation policies imposed on developing countries by the international community, such as developed countries, have the potential to be regressive in nature by increasing tax burdens on ordinary citizens in developing countries, especially on small businesses, to finance development.

Taxation has a direct effect on economic growth. The theory of supply and demand indicates that high taxation will reduce investment due to the increase in resources concentrated in the hands of government managers (such as tax havens), and capital formation will decrease due to the lack of investment opportunities. Since effective taxation encourages investment, employment generation will increase. A higher level of employment will improve living standards and thereby boost overall economic performance.

Taxation also directly affects trade. When the value of the nation’s currency decreases due to increased taxation, the loss will indirectly affect foreign trade. Thus, a country’s currency is not only an important element in international trade, but it is crucial for sustaining a competitive edge in global trade. A successful tax policy will thus lead to greater levels of national income and job creation.

Finally, a tax policy pursued with the goal of maximizing revenue will have the greatest impacts on economic development. Maximizing tax revenue will either directly or indirectly result in more investment and output, higher employment, and ultimately enhanced economic development. A successful approach to taxation must therefore take into account all relevant factors in the calculation of optimal levels of taxation. These include: the level of taxation required for economic stability; incentives to encourage investment and output; revenue maximization; access to international tax revenue sources; external financing opportunities; and the impact of changes in tax rules on important public services.

Taxation, therefore, plays a key role in the overall efficiency of the economy. Without taxation, businesses would not be able to maximize their capacity to create wealth and expand their market share. At the same time, taxes compel citizens to become more responsible, creating a better quality of life and boosting international competitiveness. Without taxation, businesses may be unwilling to invest in new, risky ventures, hindering economic development.