Question

Assume that the minister of finance was considering lowering the rate of income tax of individuals from 25% to 22%. What effects on the economy would have to be considered before such a decision could be made?

Answer 1

Lower Tax rates increase the spending power of consumers, thereby demand for products and services increase leading to higher economic growth and in this scenario there is also a possibility of Inflation, On the Supply side Income tax decrease will also increase  perks to the wage earners, thereby Production is automatically increased.

The Effects of reducing Tax rates are :-

1. Increased Spending Workers now have more income at their disposal due to the reduced tax rates and their spending power increases as they have more money to spend,.

2. Higher economic growth : With reduction in taxes now the consumer spending is increased as the standard of living of the workers is also increased and there is more demand for products and services, there by there is more money flow in the economy leading to high improvment in the growth of the Economy.

3. Government Borrowing: As the Revenue in Tax collection is reduced the Government tends to borrow in order to meet the deficit in the income reduced to the Government due to tax reduction and this scenario would lead during recession higher increase in aggegate demand. and the Govenment borrowing is also increased and this can be sourced when people with higher incomes want to save Money in the longer run, In this case the Government is injecting unused resources into the circular flow.

The Government would start selling Government bonds to the Private sector and if the Private sector purchases the Government bonds then the Private sectors investment capacity also decreases., therefore higher borrowing by the Government will lead to higher bond yields.

4. Cutting Taxes in a Boom When the Economy is already growing then there would also be a Inflationary pressure on the Economy.

5. Tax Cuts by improved Productivity. When the Government starts Tax cuts then automatically the spending power of the people increases and this leads to more productivity and there by more tax is paid by the public and this enhances better Tax revenue to the Government.