This essay will look at the effect of a change in tax rate in an economy. Based on the current economic and financial crisis relationships with be established on taxation with work incentives, labor productivity, investment decisions, budget and the rich so as to make informed opinion.
When an economy is facing a crisis, it adjusts its tax system as policy to rectify the deficit in the economy. For instance, United States has been hardly hit by the economic crisis and is contemplating on increasing taxes for the rich. The change in taxation has both positive and negative effects.
The current economic and financial crisis has adversely affected all the countries in the world. Those that have been hard hit by the crisis include the United States of America and European countries. Other countries, especially developing countries are suffering from the spill over effects. In United States, the effects of this crisis have been evident in various sectors of the economy.
The country has been hit by high rates of employment with nearly ten million people registering for the unemployment benefits. The number of people registering in job search centers has increased, with fresh graduates taking the highest percentage. The economy has failed to create new jobs, with jobs lay off mounting by the day. Most industries are streaming their workforce since they cannot adequately meet their needs, such as paying salaries and other benefits.
The situation has rendered a high percent of the populace jobless, with most of them having difficulties in paying their bills. Those who are unable to meet their bills have resorted to pegging in streets so at least to get something to sustain them. The suffering of most Americans has not gone unnoticed, with the President Barack Obama constantly giving an account of government progress on how the crisis is being handled. The most recent announcement by the President is an increase in the rate of tax for the rich.
The tax raise among the rich will lead to an increase in national revenue that can then be used to create jobs at national levels. This move has elicited controversy, with some supporting while others attack the move as inappropriate. It is like taking from those who are rich and distributing it to those who are poor. Despite raising taxes for the rich, taxes for foreign people should be lowered.
Taxation is a fiscal policy tool that government can use in order to have a balanced fiscal budget. The government to attain certain objectives like full employment, price stability and economic growth normally uses fiscal policy. Other policy tools that can be used include printing of money, sell of fixed assets, internal or external borrowing as well as consumption of fiscal reserves.
When a government is facing huge deficits, tax revenue can be raised by increasing the tax rates. Taxation is a tool that can be used to rescue an economy facing difficult times. Proper design of a tax policy can be a panacea to the prevailing economic hard times such as unemployment. United State has sought to follow Germany’s way to rescue its economic from adverse effects of its current debt position.
Economist asserts that the only way in which an economy can reverse a crisis is using an expansionary fiscal policy. This will solve the issue of fiscal budget imbalance, unemployment and ‘crowding out’ effect.
Conversely, high taxes will look out private companies from investing in the country because of the cost of production which will translates to higher commodity prices. It will be hard for businesses to carry out business in countries with high tax rates. This is because it will render most establishments less competitive in the global market.
To encourage foreign investment tax rates should be reduced for them and sometimes coupled with tax havens, allowances and subsidies, this will encourage them to take up their new investment in the economy (Kivel, 2002).
Taxation and work incentives
When there is an increase in the rate of income tax, the effect will be that the post-tax income of individuals will reduce. This is because the net income resulting from each hour of work will be lower. The move might encourage workers to increase their number of working hours to meet their target income. On the other hand, an increase in tax might be used as a disincentive to promote less work. The government normally sets a lower income tax rate for low-income employees.
This will act as an incentive for workers to do their job for long hours and earn more money. Low taxes on low-income earners serve as a tool of reducing ‘poverty trap’ risks where individuals will get high net financial benefits from their work. When tax reforms are favorable, it leads to an increase in supply of labor thus a reduction in unemployment equilibrium rate hence, the growth rate will increase.
Taxation and the pattern of demand
Demand patterns for goods and services vary as indirect taxes are changed. When value added taxes (VAT) on commodities such as alcohol and cigarettes increase, it is aimed at causing a low consumption among consumers or a substitution effect. The result will be a low demand for such commodities. Indirect taxation can be applicable where there is a total market failure, as well as when the government wants to ensure equitable distribution of resources such as health care.
Taxation and investment decisions
When the rates of business taxes and corporate tax are low, this can stimulate a business to increase its spending in fixed capital investment. An increase in investment will mean that the capital stock of a nation has increased thus an increase in capital stock of every worker employed (Mankiw, 2011).
Government can use incentives such as tax allowances to boost research and development and in encouraging new business developments. A tax regime that is favorable will attract increased inflow of FDI (Foreign Direct Investment). This will be a stimulus that will benefit an economy’s aggregate supply and aggregate demand. Low rates of corporation tax will attract huge amounts of private investment.
Tax changes act as a stimulus of investment in capital assets, social infrastructure, and labor force skills as well as in technology. A good tax system will ensure an improvement in infrastructure, which is essential for economic growth through increased production and competitiveness. Government spending can be terms of development of an education system that is skills oriented and technology focused. This will ensure a steady long-term supply of human resources (Dye, 2011).
Company’s risk attitude and corporate income tax are the main factors that are considered by an organization before making an investment decisions, this is because this factors can affect the rate of return on investment. Amount of corporate tax to be paid is an important factor that is taken into consideration before making a financial investment decision. This is because low taxes will mean lower prices for goods and higher revenue generated.
The Rich Should Pay More
For equal sacrifice and fairness among citizens, those individuals who benefited from favorable economic times such as boom, rescue packages among others should find it necessary to shoulder the costs that arise from a crisis. There willingness will save the economy from suffering the worst effects of a crisis that a time may spill over to drain resources of the rich. This argument looks at increasing government revenue through an increase in income as well as an increase in capital gains tax.
This was illustrated by Germany’s case after the World War II where legislation was passed which mandated financial compensation to gather for loses that arises during the war. This lead to a creation of tax on property and capital, this law was applicable to individuals who still possess substantial assets after the war. The law required them to pay half of their asset worth to a compensation fund over a period of thirty years.
In case of United States, an increase in tax has no chance any time soon. The reason being the required budget consolidation should occur on the expenditure part. This will imply a reduction in government expenditure and this will have adverse effects on the economy. On the other hand, an increase in income tax disproportionately has an effect on higher earners. The impact of high tax on the rich is minimal because large proportions of their income go to savings while minimal amounts are spent (Blinder & Baumol, 2011).
United States cannot undertake spending cuts since it will adversely affect their growth. This is because the economy is spending less on infrastructure, education and social transfers. For other countries that are facing similar crisis, an increase in government revenue will serve the country better. Therefore, if Americans refuse to contribute more to their economy through tax, they will suffer from a middling economy.
Taxation as an expansionary fiscal policy is applicable when an economy is facing difficult economic times, where the government spending exceeds its revenue significantly. The current financial and economic crisis has led to increase of tax rates to generate more revenue.
The revenue generated is ploughed back to the economy to offset the high standing levels of debts. Increased tax will hurt the economy in terms of reducing the disposable income of consumer and investment income for companies. Individuals will be left with insufficient money to spend hence a decline in aggregate demand. The rich should make a greater sacrifice to shoulder the costs that have accrued due to a crisis as the low-income earners still pay their tax at the usual lower rates.
Poor economic standing of an economy will imply that sectors such as education, health care, communication, physical infrastructure among others will suffer, yet they are the main drivers of economic growth. A good tax system should be developed to realize economic progress.
Good taxation we stimulate accumulation of capital stock in the economy in terms of new industries being set up and new technology adopted. This will ensure that the rate of unemployment reduces with a significant margin. Increase the tax rates for the rich will increase the revenue base of a country with the money generated channeled towards job creation in the economy.
An economy in a crisis should receive compensation from those who benefited from it during good times such as times of rescue package, social transfers and boom. The wealthier should make huge sacrifices in terms of tax payment even though the burden may be overwhelming. A good tax system should act as a magnet for attracting foreign investors through the provision of tax haven for newly established industries. This will encourage foreign investors in the country; hence help in solving the problem of unemployment.
Blinder, A. S., & Baumol, W. J. (2011). Macroeconomics: Principles and Policy. New York: Cengage Learning.
Dye, T. R. (2011). Understanding Public Policies (13th ed.). Boston: MA Pearson.
Kivel, P. (2002). Uprooting racism: how white people can work for racial justice. New York: New Society Publishers.
Mankiw, N. G. (2011). Principles of Economics. New York: Cengage Learning.