How Do Taxes Affect Economic Growth?

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The impact of taxes and public spending on economic growth has become a subject of much discussion and debate among economists. This is partly because there are many theories regarding what propels and facilitates economic growth: while some favour the Keynesian demand side factors, others Neo-classical supply side factors, while yet others consider a mixture of the two or another theory altogether. However, the world economy is sufficiently large and complex enough so that any theory can find some support in the data. By implementing changes in tax rates and public spending, the government can influence the economy, through what is popularly known as fiscal policy. There are strong proponents as well as opponents for cutting taxes and public spending. In fact, this debate has given way to staunch political ideologies as is the case with the United States. In the USA, the Democrats favour higher taxes, especially for the rich, and…show more content…
There has been a lot of research conducted on the merits and demerits of taxation. Let us look at how increasing tax rates can have a positive impact on the economy. Governments sometimes implement tax hikes to control inflation by reducing the disposable income of households. Disposable income refers to the money available to households after paying income tax. When excessive demand drives up prices (inflation), increasing taxes reduces the disposable income of households which results in lower demand and thereby reduces the upward pressure on prices. Taxes have also been historically seen as a way to normalize incomes in an economy. Higher tax brackets for the wealthy compared to the middle and lower class is an idea that finds as many supporters as opponents. The proponents for higher taxes for the rich and more public spending argue that inequality of incomes is not just morally and ethically wrong but also affects the economy
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