Question

In: Economics

Assume that you work for a large manufacturing company that utilizes both capital (K) and Labor...

Assume that you work for a large manufacturing company that utilizes both capital (K) and Labor (L) in the production process. Explain how a tax on capital would affect your operations and how you would estimate the welfare effects on your company.

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Expert Solution

Ans-

Effects of increase in tax on capital:

1. Higher tax on capital affects the business decisions along with investment decisions at all levels.

2.Increase in tax on capital may reduce the number of new investments and affects expansion of old business organizations.

3.Tax on capital influences the overall economic activities and distribution of resources in the country.

4.Higher taxes on capital increases the cost of production, ultimately the prices of goods increases and results into reduction in demand and shifting of demand curves downwards.

5.Higher tax on capital results into higher production cost which may reduce the incentive to work and labor supply may be affected.

6.Due to low wages, productivity of labor is affected which will result into low production at higher costs; overall profitability will reduce.

7.Economic growth rate may be affected because of reduced output due to low investments ,no new business set up can started,limited expansion of business etc. All this affects lower GDP along with the economic growth rate.

8.Inflation may also increase due to high tax on capital, increase in production cost etc. Therefore, price of goods and services also increase without increase in the income levels in the country, resulting to inflation.

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Welfare effects of tax on capital depends on the distribution of tax revenue as well as tax system:

1. If revenue from tax is used for Government spending or repayment of debt, then it will reduce the welfare of individual as revenue from operations will not be utilized for welfare activities.

2.If tax from capital revenues are transferred for welfare activities, it will increase the welfare of the state steadily.

3.When tax revenue from capital is rebated to tax payers, a new capital tax may increase welfare when the growth rate is relatively high.

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