Question

What is the relationship of inflation and taxation? Would taxation be considered as the tool to control money supply?

Answer 1

Relationship between inflation and taxation

First lets look into the concepts of tax and inflation in a simple mannet ,tax is required payment to a local, State or national government.It's a way for government to raise revenue.lnflation is a sustained rise in the general price level of an economy over a period of time,in other words it means too much money chasing too few goods

Tax rates and inflation have some sort of a negative relationship.

If a country increses tax rates,disposible income(income left after the payment of taxes) will decrease.When people have less disposible income , aggregate demand will decrease.As a result, price level will decline.

On the other hand if taxrates are cit., people will have more income to spend, aggregate demand will raise and price level will increase.

Taxation as a tool to control money supply

There are two kinds of policies mainly adopted to keep economic growth stable with stable prices- Monetary policy and fiscal policy. Monetary policy is adopted by the central bank and fascal policy is adopted by the government.Taxation is one of the tools effectively used by the government to to tackle the situations of both inflation and deflation.

How ever taxes doesn't affect the money supply directly.Taxes results in a redistribution of income and wealth.They impact the economy through their impact on demand.

During the period of inflation,by raising taxes governments pull money out of the economy and slow economic activity.

During deflation, government cuts taxes so that more income stays in the pockets of businesses and their employees as well as consumers which in turn stimulates aggregate demand and raises price level.