One
of the most important objectives of government policy is to create a more equal
distribution of income and wealth. The uneven distribution of income and wealth
may be a partial result of the uncontrolled exercise of market forces. Taxation
which falls more heavily on the better off groups is one policy instrument used
for this purpose.
Taxation
will also have many economic effects. They are the effect of taxation on
1) distribution of income 2) consumption 3) incentives 4) saving and
investment 5) prices.
1)
The effect of taxation on distribution
of income: - Direct taxes will reduce the disposable income of firms and
households. The income remaining after taxation will be less unequally
distributed than before tax. Indirect taxes are also affecting the distribution
of income. The commodities which are heavily taxed are widely consumed and have
price inelastic demand. Lower income groups tend to spend a greater proportion
of their income on some of these commodities, so the effect of tax is
regressive (e.g. tobacco) Higher income groups in western countries consume
more alcohol which are subject to higher tax, so it to act progressively.
2)
The effect of taxation on consumption:
- Direct and indirect taxes will affect both the total and the
pattern of spending. Direct taxes reduce disposable income, but the
effect on consumption will depends on the propensity (tendency) to consume and
the level of savings. Direct tax payers are enjoying a relatively high standard
of living, which enable them to save. When taxing, they resist any cut in
standard of living, reduce saving than spending. Indirect taxes will
affect the total demand for goods and services. When tax is imposed on
commodities with price inelasticity of demand, consumers will tend to maintain
their consumption of these goods by reducing spending on other goods and
services. This also will depend on the propensity (tendency) to consume
and the level of savings.
3)
The effect of taxation on incentives:
- New levels of taxation will result in less effort, less investment and less
risk-taking, because taxation will make the net rewards for extra work and
responsibility seem very unattractive. (This argument applies particularly to
progressive taxation where additional income is taxed at higher rates) Another
argument is that the additional taxation will increase the workers’
efforts. A person accustomed to a certain standard of living, will work
harder or longer to maintain the same disposable income.
4)
The effect of taxation on saving and
investment: - Heavy and steeply progressive taxation will reduce the
ability to save, it also might reduce the willingness to save. Capital transfer
and wealth taxes might also reduce the willingness to save. Private investment
is determined largely by expected profitability, so tax on profits will also
have disincentive effects. It is very difficult to determine the strength
of these effects, since so many factors influence the level of
savings.
5)
The effect of taxation on prices:
- Direct taxes fall on income and have no direct influence on the price level,
but indirect taxes have an immediate impact on prices. Direct taxes may
lead to a significant fall in demand which in turn lead to a fall in price, but
present day conditions it is more likely to reduce output rather than
prices. An increase in indirect taxes is a powerful generator of cost
–push inflation (depends upon the weighting of the taxed commodities in
the Price Index). An increase in the direct tax could stimulate wage
demands and so lead to cost-push inflation.
On
considering the above the government estimate their spending and revenue of the
coming year which is known as the budget.
This is presented to the parliament in advance. The two main purpose of
the budget are to announce the pans for government spending and taxation and
through these to influence the economy. Government in fact uses this to influence inflation, employment
and output. Sometimes government is spending more than it receives
in tax revenue which is known as budget
deficit. More money in an economy is likely to cause increased spending
on goods and services and so increase employment. Just as an individual
has to borrow if he/she spends more than he/she earn, so does the
government. The amount of public sector borrowing each year from the private
sector and overseas is called the public
sector net cash requirements. Government borrow using Treasury bills [short term debt repaid by
government with interest after 91 days] and gilt edged securities [long term for up to 25 years, each year
holder receives interest like dividend on a share] Government also borrow
the savings of the people in the national
savings banks.
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