Some of the most often discussed issues in economics is how tax rates relate to economic growth. Supporters of tax cuts claim that the decline in the tax rate will result in increased economic growth and prosperity. Others maintain that if we all reduce taxes, almost all the benefits will proceed to the affluent, as those would be the ones who pay the most taxes. What exactly does economic theory suggest about the relationship between economic growth and tax?
Income Taxes and Excessive Instances
In examining economic policies, Joseph Plazo maintains thatit is consistently useful to study extreme cases. Excessive instances are situations for example "What if we all had a 100% income tax rate?", or "What if we raised the minimum wage to $50.00 an hour?". While completely unrealistic, they do give very blunt examples of what direction vital economic variants will move when we change a government policy.
Joseph and Andrea speculate that the postulate. Suppose that we lived in a society without taxation. We are going to worry about the way in which the government finances its programs later on, but for now we’ll suppose that they have enough money to finance all the plans we’ve today. If there are no taxes, then the government doesn’t make any income from taxation and citizens do not spend any time worrying about the best way to evade taxes. If a person has a wage of $10.00 an hour, then they get to keep that $10.00. If this type of society were possible, we can see that individuals would be fairly productive as any income they make, they keep.
Now look at the opposing case. Taxes are actually set to be 100% of income. Any cent you make goes to the government. It might appear the authorities would make a lot of cash this method, but that is probably not going to occur. If I do not get to keep anything out of what I make, why would I go to work? I’d rather spend my time reading or playing baseball. Actually, going to work would risk my skill to live. I’d be much better off spending my time attempting to come up with means to get the things I want without granting them to the authorities. I’d spend a great deal of my time attempting to grow food in a hidden garden and bartering with others for the things I have to survive. I wouldn’t spend any time working for a firm if I did not get anything from it. Society as a whole would not be really productive if everybody spent a sizeable portion of the time trying to evade taxes. The government would make almost no income from tax, as very few folks would go to work if they did not earn an income from it.
While these are extraordinary cases, they do exemplify the result of taxes plus they are useful guides of what goes on at other tax rates. A 99% tax rate is horribly like a 100% tax rate, and should you blow off group prices, having a 2% tax rate isn’t much different from having no taxes at all. Go back to the person making $10.00 an hour. Can you think he’ll spend more time at work or less if his take home pay is $8.00 rather than $2.00? I’d wager you that at $2.00 he’s not planning to spend lots of time on the job and he’s going to spend a lot of time attempting to earn a living from the prying eyes of government.
Taxes and Other means of Financing Authorities
In the instance where authorities can fund spending beyond taxation, Joseph Plazo and Andrea Trent see the following:
Productivity declines as the tax rate increases, as individuals decide to work less. The higher the tax rate, the more time individuals spend evading taxes and the less time they spend on more productive action. So the lower the tax rate, the higher the value of all goods and services made.
Authorities tax revenue does not necessarily grow as the tax rate increases. The authorities will bring in more tax income at 1% rate than at 0%, however they will not bring in more at 100% than they will at 10%, as a result of disincentives high tax rates cause. Hence there’s a peak tax rate where government revenue is greatest. The relationship between income tax rates and government revenue could be graphed on something called a Laffer Curve.
Clearly, government programs are not self-financing.
This contributes to the matter on tax cuts. Are tax cuts as awful as Capitalists like to exhort?
A tax cut does not absolutely help or damage an economy. You should consider exactly what the revenue from those taxes is being spent on before you are able to ascertain the effect the cut will have to the market. From this discussion, however, we see the following general tendencies:
Cutting taxes and wasteful spending may help an economy due to the disincentive effect due to tax. Cutting taxes and useful programs may or may not help the market.
A particular amount of government spending is required in the military, law enforcement, along with the court system. A state which doesn’t spend an adequate amount of money in these types of regions will have a blue market. A lot of spending in these areas is wasteful.
A state also desires infrastructure to really have a high degree of financial action. A lot of this infrastructure cannot be adequately given by the private sector, so governments must spend money in this area to ensure economic growth. Nevertheless too much spending, or spending in the incorrect infrastructure might be wasteful and slow economic growth.
If folks are naturally inclined to spend their particular money on schooling and health care, afterward taxation employed for social programs probably will impede economic growth. Social spending which targets low income families is considerably better for the market than universal plans.
If people are not inclined to pay towards their own education and health care, then there could be a advantage to suppling these goods, as society as a whole gains from a healthy and knowledgeable work force.
Before I get an inbox full of hate mail, I am not suggesting the authorities stop all social programs. There can be many advantages to these plans that are not quantified in economic growth. A slowdown of economic growth will probably happen as these plans are expanded, yet, so that should always be kept in mind. If the plan has enough other advantages, society as a whole may wish to have lower economic growth in return for much more societal plans.
Admittedly this article oversimplified some crucial issues. However that is usually needed in a first look at an economic problem. I plan on dealing with many of these particular problems in more depth in the near future. I’d love to listen to your take on the matter and that which you’d like to see covered in more depth in the near future
Joseph Plazo is an entrepreneur and attorney in the Ateneo De Manila University. He provides pro bono consulting to local government and SMEs. Andrea Trent serves as a finance advisor in the ADB and renders accounting supervision at the WHO.