How Taxes Affect Economic Efficiency - Essay Example

?How taxes affect economic efficiency The topic of potential benefits of taxes on the economic efficiency of a country has gained much attention in the recent years. It is true that various initiatives taken by a government have a significant impact on the scope of economic activities. During the last few years, myriad studies have been conducted on taxes in order to find out whether they have any impact on economic behavior or not (Kroeger 2011). The effect of tax reductions is often debated. According to free market economists, tax deductions result in economic growth. According to Keynesians, tax cuts have a negative impact on the growth of wages (Ryan, 2011). There are some countries where governments encourage international trade while on the other side, some raise barriers. Some governments impose just enough tax to support various government expenditures while some levy taxes which burden the whole population (Kroeger, 2011). Adam Smith is revered in the field of economics because of his remarkable work on free-market economics and taxation. There are many economists of the modern times who consider Adam Smith the best tax economist of all time. According to Smith, the resources of a nation are allocated in the most efficient manner through an 'invisible hand'. According to Smith's view, taxes should be levied in such a way that they optimize and satisfy four variables. These variables include equity, transparency, convenience, and efficiency. According to Smith, by imposing limited taxes, economies can maximize their wealth (Kroeger, 2011). Taxes are imposed by a government to support some basic functions. These legitimate functions include education, defense, and the construction as well as maintenance of roads. In a market economy, the allocation of resources depends on the forces of demand and supply. In order to understand the ultimate impact of tax on economics, it is imperative to evaluate this impact in terms of the purchasing power of individuals as well as the economy's aggregate supply. One of the basic concepts of economics is that an increase in demand leads to the production of more goods and services in order to fulfill the demand. It implies that if producers can sell more because of an increase in demand of their products then they need to produce more goods to satiate the increasing demand. The imposition of tax deprives tax payers from a portion of their money that they would have spend on consumption. If it is accepted that the imposition of tax only deprives people from money than it would be concluded that taxes have a negative impact on economy. However, by looking at the other side of coin, it can be comprehended that the money which people spend on taxes eventually turns into government's income. Government spends this money on the welfare of the public which in turns enhance the economic growth (Kroeger, 2011). The income of one person depends on the spending of others. When government spends the money, it ultimately turns into the income of the public. Similarly, when the public pays taxes, it becomes the income of the government. So, it is wrong to say that the imposition of taxes drops the aggregate spending in fact it causes it to increase. If tax payers save their money instead of paying taxes, it will impact government expenditures and will decrease the overall consumption and in turn the overall economic efficiency. Similarly, if government saves money and does not spend it then it would ultimately affect the public. It proves that the act of saving money is not beneficial for the overall economy of a country but it creates problems. This act is really harmful for the economy of the country. A very obvious example of the harmful effects of this act is the Great Depression. The Great Depression occurs because people who could have opted for spending money chose to save it. However, those who wanted to spend money were deprived of it (Kroeger 2011). The long term expenditures of government increase with the growth of population. Therefore government needs money to improve the well-being of the growing population. There is no apparent evidence which proves that taxes make an economy inefficient. An increase in taxes shifts the spending decision from the private sector to the public sector. In this regard, it is important to ensure that there exists sufficient total demand. It is true that taxes are necessary to ensure economic efficiency however on the other hand; income taxes decrease the incentives to generate income (Kroeger, 2011). Since the last decade, the Internet has become the ultimate constituent of this global world. In the developed economies particularly, the Internet has been penetrated into various fields such as education, business, healthcare, and worldwide communication. The rapid penetration of the Internet has resulted in an increase in the number of jobs available to people living in different parts of the world. The incorporation of the Internet in various arenas has also made several countries technologically advanced. There are several organizations which have expanded their business beyond their borders. It has resulted in the growth of several multinational corporations. The Internet has significantly enhanced the growth of world economics (Kalaw). E-commerce is soaring these days because of the endless opportunities it has provided to buyers and sellers. The issues of free shipping and sales tax have created a battle. The issue has become very urgent in the United States particularly. The country is confronting budget deficit and the economy is under heavy pressure to find sources of revenue. E-commerce is growing very fast in the United States. The lawmakers of the country have joined their hands to make online sellers and buyers accountable for taxes. Consequently, a bill of $269 million has been presented to Amazon which is one of the biggest online market space (Gleckman, 2011). The improvement of tax system is one of the major challenges faced by developed economies. The political importance of taxes is not limited to fulfill the basic needs of the population. However, the development of an appropriate tax system is necessary for state building. The tax system can not only help in improving the state but can also strengthen democracy and promote state’s legitimacy. In order to explain the development of states and democracies, the proper concept is ‘fiscal social contract’. Historical trends in Western Europe and North America have proved that taxation can contribute to make economies more accountable. In this connection, the role of business organizations, trade unions and consumer organizations is crucial (Fjeldstad, 2011). The development path of East Asian countries is different from western countries. However, the tax system has been proved as an important component of the development of this region. Taxation has supported economic policies in South Korea and Taiwan that have promoted economic development as well as the development of public institutions. In order to develop an effective tax system, the authorities in Taiwan has developed an extensive database which includes businesses as well as households. The authorities narrowed their focus on the development of a tax system that ultimately became the basis of the development of the state. A part from Taiwan, the tax system has also been proved as an important factor for the development of an effective state in Latin America and Africa. When a state builds an effective tax system, the authorities have incentives to develop rural and peripheral areas. In this perspective, it is not a challenge to impose more tax but to tax a large fraction of population. However, it is difficult to implement because of the presence of informal sector. The informal sector is a common characteristic in poor countries (Fjeldstad, 2011). Conclusion The formation of an effective tax system has become a major challenge these days. The impact of taxes on economic efficiency has become a major debate in several countries. Economists present diverse viewpoints regarding positive and negative impacts of taxes. Taxes are imposed by government to overcome the cost of government expenditures. The money earned by government from taxes is ultimately used for the well-being of the society. It implies that imposition of taxes result in economic efficiency. However, according to another point of view, when taxes are imposed, the motivation to invest is suppressed. It ultimately results in fewer investments which lead to inefficiency. Historical trends and experiences have proved that an economy becomes inefficient when money, which should be utilized, is saved. The Great Depression is the best example to prove this fact. The Great Depression occurred because the money which should be invested was saved. Work Cited Kroeger, J. “Do Tax Cuts Stimulate the Economy?” Nontrivial Pursuits.com. Non Trivial Pursuits. n.d. web. 24th September, 2011 Ryan. “Do tax cuts spur economic growth?” swifteconomics.com. Swift Economics. n.d. web. 24th September,2011 Kalaw, M. “The Internet and its Effect on the Economy and Government”. people. hamilton.edu. The Dark Side of the Internet n.d. web. 24th September,2011 Gleckman, H. “The battle over Internet sales tax.” csmonitor.com. The CS Monitor. March 8, 2011. web 24th September, 2011 Fjeldstad, H.O. “The importance of taxes for development.” regjeringen.no. Ministry of Foreign Affairs. June 2011. web 24th September, 2011 Read More