Question

Using examples, explain how the behavioural effects, financial effects and organizational effects of tax systems can affect economic efficiency.

Answer 1

Taxation is an important feature of an economic system which forms a major part of revenue to the government to run an economy in an efficient way. The various responses to the taxation system would have clear effects on the efficiency of an economy. The behavioural, financial and organizational effects of tax in the efficiency of an economy is discusses below.

Behavioural effects of Tax system and Economic efficiency

· Behavioural effects refer to how the taxation policy influences the consumer behaviour in an economy that could have effects on how efficiently an economy works.

· For example, consider the imposition of a ‘sin tax’ in an economy. This taxation policy would mean that the heavy taxes are imposed on products that affects a society or sin products like alcohol, cigarette which would mean that the consumption of such products would reduce by a considerable amount and thus would lead to improve the employment readiness of an economy and health of an economy which would make an economy further efficient. Moreover, if the consumption is not affected, it would also mean that the revenue from such taxes could be spend in other needy sectors

· The imposition of a luxury tax has similar effects in an economy. Here, the taxation doesn’t have effects on the consumption of non-essential goods which represents the behavioural pattern of a society and hence the taxes collected could be utilised in other sectors which could improve the economic efficiency.

Financial effects of Tax system and Economic efficiency

· The financial effect of a taxation system would mean the difference of revenue generated by taxation policies in an economy.

· With increased taxation policies, the revenue generated by the government would increase which would mean that the government now has more money to spend in the basic building of its economy which would have positive effects on the society thereby increasing the participation of people in such a society and helping to attain economic efficiency. But, it has another effect that with increased taxation, the disposable income of an individual gets reduces which would reduce consumer spending in an economy and thus may lead to lower investment policies in an economy and hence may affect the production and efficiency

· Similarly lowering of taxes would mean that a government is left with lower revenue to cater the basic sectors of the society, but it would lead to an increase in the consumer spending and investment which could boost the production potential of an economy and hence attain economic efficiency in the short run.

Organizational effects of Tax system and Economic efficiency

· The organizational effects of a taxation system can be better understood from the varying levels of corporate tax, sales tax etc that is imposed on various organizations of an economy.

· With increase in corporate taxation, it would mean that the profits of an organization in the market are reduced which may result in less attraction for new organizations to enter the market and hence may result in the reduction of economic efficiency.

· When organization friendly taxation systems are followed, it would mean that more organizations would be attracted to do business in such an economy which could improve the production potential of that economy and hence would end in improving the economic efficiency

                                                 All the above factors discuss on the various effects of taxation in an economy and how they result in affecting the efficiency of an economy. From the above, it is clear that an investor friendly taxation policy would boost and economy even if the revenue of the government is falling and vice versa.