Taxation and Growth in the UK - Essay Example

Introduction A tax policy is an instrument that policy makers of a certain make in order to assist in collection of taxes. It uses different bases on different people and corporations to be able to collect as much tax as possible. These taxes are the major source of revenue for any government in the world and hence the tax policy acts as a guideline in achieving their revenue targets through taxation. Different countries adopt different tax policies that are suitable for their economies (Auerbac & Gorodnicheko, 2010). During an economic recession, there is a widespread drop in spending or decrease in demand, and the economy faces a lot of inflation that is the general increase in the prices of all goods in the economy. This affects the level of growth in such an economy since most of the income is used on consumption and very little is spent on growth and development. Therefore, the level of growth declines significantly. This can be reversed during economic recovery by use of fiscal policy. This is where the government uses taxation or fiscal policy measures to be able to control the economy (Barro & Gordon, 1984). U.K experienced an economic recession between 1998 and 2012. This was stimulated by the worldwide inflation that was affecting the economy in terms of prices of goods. The government of U.K adopted the use of tax policies to be able to gain economic recovery and growth. Tax policy can be used to stimulate economic recovery and growth in various ways according to Bent (2003). This includes: Increase in demand Increasing demand is a tool for short-term recovery. This can be done through reduction of consumption taxes. In return, people will spend more hence; there will be an increase in demand, which will stimulate business in the economy. Hence, economic recovery in the short run will be achieved. Increase in supply Increasing the supply in the economy would stimulate long-term economic recovery. This can be done through reducing the taxes for inputs and raw materials that will make them cheaper to stimulate supply. This will therefore lead to increased supply in the economy since suppliers can be able to buy more goods to supply their goods to the market, which leads to economic growth through trade. Reduced taxes for low income earners Low-income earners have very little disposable income. If the government would reduce their taxes, the little income that would be saved would stimulate demand and hence help the economy recover from recession. This is because low-income earners have little to save and to invest meaning that most of their income is used to buy basic commodities. As a result, demand increases and the economy grows significantly. Increase taxes on consumption Consumption is a daily activity for every person. This gives the government a chance to utilize the revenue they get from taxing such consumption. An example of such taxes is Value Added Tax. This tax is imposed on most of the goods that are for consumption. Increasing such taxes enables the government to collect a lot of revenue which will aid it in investment projects that had been budgeted for such as improving infrastructure. This will in the end lead to growth in the economy. This additional revenue helps reduce the budget deficit and thus lead to growth. Increasing government expenditure The government includes in its budget an amount to cater for its expenditures. Such expenditures include; transport and communication, security, youth and women empowerment healthcare and education. By increasing government expenditure, the economy will be stimulated, and hence in the end it will increase the growth rate. Government expenditure can be either productive or non-productive. Productive expenditure is said to have a direct impact on increasing growth in an economy as opposed non-productive expenditures. However, this poses a great challenge for the policy makers since it is not easy to classify expenditures as either productive or non-productive. However, increase in the government expenditure leads to growth since more is spent on projects that the government had intended to carry out. As a result, these projects start generating income and hence lead to growth through creation of employment and increase in GDP. Lowering the tax rates In order to stimulate investments, the government has to give the investors an incentive for their work. This can be done by lowering the tax rates. According to Jenkins (1989) and Marsden (1990), lowering taxes stimulate growth by increasing the incentive to save and invest.This is because lower tax rates encourage people to invest.This is a fiscal policy measure that the government can use in order to achieve growth in an economy facing recession. Adopting an optimal tax mix A tax mix is a combination of different taxes that a country collects in order to get the maximum revenue. A country that has a good tax mix can enable a country to be able to achieve growth in the long run. This is because the government has enough funds to finance its budget. Hence it can achieve growth. However, there is a challenge in coming up with the appropriate tax mix since they vary from country to country. Tax incentives For an economy that is experiencing recession, tax incentives are very essential for growth.These tax invectives include tax holidays where investors of various risky but highly profitable areas are given such tax holidays. Also, the government can reduce the tax rate for industries that produce for export. This exempts them of some taxes hence they are able to plough back ore profits to those investments. This in turn stimulates growth as more potential investors venture into such areas and thus an economy recovers from recession and in the end, it grows. Capital deductions/allowances These are allowances that investors get on assets that reduces their tax. There are several types of capital deductions such as wear and tear allowances, industrial building deduction and investment deductions. In investment deduction, the state refunds to the investor the value of the asset claiming capital deduction. This enable investors to purchase assets that grow their businesses and in the long run assure the state of economic growth. For example, industries that purchase heavy machinery should claim for investment deduction, which is paid once, and this would help recover the cost of the machine. Therefore, the government has many options in implementing tax policies that help in economic recovery and growth. These taxes however have negative implications on the economy. Such implications include inadequate incomes, low wages for the workers, high prices of goods, unemployment as many businesses close down etc. These implications if not well controlled can lead the country back to recession. Therefore, the government has to put in place control measures in order to avoid the tax policy leading to worse economic conditions (Wilcox, 1987). In the U.K during the global recession, there were some fiscal measures adopted. This included tax cuts for low-income earners and a tax cut for the VAT. There was also a scheme for small enterprises named the Small Enterprise Loan Guarantee Scheme that encouraged people owning small enterprises to take loans for investment. Kneller et al (1999) found that taxes have a negative effect on incomes. This is true according to the survey done by U.K experts on the effects of their tax policy during the great recession. Taxes lead to negative implications to incomes because of the following reasons. 1. Taxes leave the income earner with very little or none to save. This means that the income earner cannot be able to save or invest because of the low income. 2. Taxes also reduce the purchasing power of the income earners such that the goods they purchase have high prices. For instance one pound before the recession could buy three pens while due to increase in tax ,a pound can only buy one pen, This means that due to the tax the purchasing power of the incomes have reduced significantly. 3. Taxes raise the cost of living of people since the little income they have has to supplement for the various needs, which are expensive to satisfy. 4. The disposable income of an income earner also reduces due to taxation. This therefore means that he has little money left to spend on goods. In the long run the demand for goods reduce and hence causing the incomes of sellers of goods to reduce too. In the Mendoza and Ostry (2007), consumption taxation that is non-distortional and thus has no effect on the growth rate becomes distortional, with a (negative) effect on growth if leisure is included in the utility function, affecting education labour leisure choices and thus capital / labour ratios in production. This is because they advocated for consumption taxes as they do not have an effect on investments, hence increases the growth rate. This is contrary to what the economists in U.K put forward since they analyzed that the tax policy has some effect on consumption. Consumption taxes have an effect on the economy as put forward by Heyne, Boettke and Prychitko (2002). This is because when consumption goods are taxed, there is a reduction in the disposable income of the people and hence affects investments. This in the long-run reduces the growth rate of the economy. Additionally, consumption taxes reduce the demand for goods. This in turn leads to less income for the suppliers of goods who in the end do not contribute to the growth of the economy. Therefore, this paper has found out that the fiscal policy used in the U.K to counter the great recession by use of consumption taxes does not agree to the Kneller findings that consumption taxes do not have any effect on the economy. It has also analyzed that the use of fiscal policy such as consumption taxes have effects on the economy. Therefore, the government needs also to put in place appropriate control measures to be able to eliminate the recession without compromising the economic benefits. The fiscal measures that were being effected by the U.K government were based on the Keynesian theory which according to Blinder (2008) advocates that the solution for the recession is stimulating the economy through government expenditure. Conclusion and Recommendations This paper is based on the fact that, various economies can be faced by a recession, which can be dangerous. According to Larch and Nogueira (2009) use of fiscal measures comes in handy to help the economy be able to recover and also increase its growth rate. These fiscal measures ensure that the supply of money in the economy is controlled to avoid excess money supply, which fuels inflation. In addition, the fiscal measures help the government to be able to stimulate aggregate demand and in the long-run increase the growth rate. The government needs a lot of funding to be able to achieve its budget. This is mainly from taxes that are collected according to different bases and finance the budgets. Therefore increasing the taxes means that the government is able to collect a lot more resources that usable to stimulate the economy through investments and hence lead to increased growth rate (Feld & Frey, 2002). During this analysis, this paper has found that as much there are various benefits of using the fiscal policy to gain economic recovery and growth, there are also negative effects as earlier mentioned. These include unemployment, low savings and investment, high prices for basic goods and many others. This paper recommends that various policy makers should take into account these negative effects in order to be able to attain growth in the end. Finally, as put forward by Weil (2008), in order to safeguard an economy from suffering a recession, it is essential to be able to guard against the factors that may lead to a recession. These factors include increased costs of goods such as oil, increased money supply, adverse supply shock and many more. Guarding against these factors will help the government in avoiding dealing with such a financial crisis. References Blinder, S., 2008. "Keynesian Economics". In David R. Henderson (Ed.). Concise Encyclopedia of Economics (2nd Ed.). Indianapolis: Library of Economics and Liberty Hansen, B., 2003, The Economic Theory of Fiscal Policy, Volume 3. London: Routledge. Heyne, P. T., Boettke, P. J., and Prychitko, D. L., 2002, The Economic Way of thinking (10th end). New Jersey: Prentice Hall. Kneller, R., Bleaney, M.F. and Gemmell, N., 1999, Fiscal policy and growth: Evidence from OECD countries. Journal of Public Economics 74 (2): 171-190. Larch, M. and J. Nogueira Martins, 2009, Fiscal Policy Making in the European Union – An Assessment of Current Practice and Challenges. London: Routledge. Mendoza, E. & Ostry, J., 2007, "International evidence on fiscal solvency: Is fiscal policy "responsible"?" Journal of Monetary Economics, Elsevier Weil, N., 2008, "Fiscal Policy". In David R. Henderson (Ed.). Concise Encyclopedia of Economics (2nd Ed.). Indianapolis: Library of Economics and Liberty. Hakkio, C. & Rush, M., 1991, “Is the budget deficit “Too Large?”,” Economic Inquiry 29 (3): 425-45. 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