Effect of Taxation and Tux Cut - Assignment Example

Taxation 05, April Taxation is the payment made by the people to the government which no services or goods are provided directly to the people who have made that contribution. The amount an individual contribute as a tax does not account to the benefit or provision that he or derives from using public goods and services. There are many arguments for taxation, but depend with the circumstances at a particular period. In the advent of taxation, the British authority needed revenue to finance the war and management of colonies in the U.S. During the 1930s, the principle reason for taxation was to pay for government expenditure (The Principles of Taxation). In recent time different type of taxation function differently and it explain their reason for resource allocation, income distribution and aggregate demand in the economy. According to Modern Monetary Theory, taxation is a necessary tool used in controlling the amount of money in the economy. Taxation ensured that government spending is done while checking on the increase in inflation. Government spending increases the supply of money and boosts the countries spending in the short run. Taxations of the spending ensure that it reduces the supply of money and thus reduces inflations in the long run. Through taxation the governments ‘does eat the cake and have it.’ Public expenditure ensures people are provided the necessary services and at the same time government collect revenue out of money paid in completion of its projects. All forms of taxations are believed to have an impact on the allocation of resources with except of poll tax. Taxation changes the relative prices of goods and services making both producers and consumers adjust accordingly whenever there are changes in taxations (The principles of Taxation). Therefore, government taxes producers in specific economic sectors to discourage the inefficiency. For example, the increase in alcohol beverages taxation is ensured to discourage on the consumption of alcohol in the economy. According to the U.K government, the consumption of alcohol reduces the productivity of the people which in turn reduces the countries incomes. In an economy, there are public and private goods. Moreover, the production of these goods results to production of externalities as byproducts. The production process can produce negative and positive externality, and it is the function of government to control on the production of the negative externality. This reason gives the government power to use the power of taxation to minimize or remedies the effects of the negative externality. The government has introduced the Value Added Tax to control the level of negative extremities among manufacturing industries. Moreover, the UK government implements the European Carbon tax which taxes industries that use gas, coal and other fossil fuel as a source of energy (Carraro 1993). The tax aims at reducing the emission of carbon dioxide in the environment. Keynes introduced the theory of aggregate demand and supply and argued that the lack of balance between demand and supply results to economic loss (Barro & Redlick). Therefore, the management of the aggregate demand and supply help to regulate the economy to function optimally. Therefore, for this reason the government taxes can be increased or decreased when a country is experiencing a boom or recession. Taxes, therefore, are an important tool in the management of demand. The U.K government has in the past reduced income taxes during the Great depression. Another reason for taxation is that it enable for the provision of public goods and social program to the people of a given country. The UK government has been paying unemployment levies to the unemployed youth in the past’s decades. Moreover, the government provides the largest share toward public health care provisions while the public contribute a small percent of the cost of health care. The provision of roads, rail and other infrastructure attract huge financing that cannot be met by the private investors. Therefore, to ensure that these goods are available for public uses the government need to tax its citizen to raise the much needed revenue for this course. Question b The government uses fiscal and monetary policies to stimulate economic growth of the country. Fiscal policies involve increasing or decreasing government spending and raising or cutting taxes. Therefore, the effects of cutting taxes stimulate economic growth just like increasing government spending. Tax cut affect individual income and behaviors of household differently from firms and other corporate organizations. Question b (i) A direct tax cut has both the income effect on individual and firms. Therefore, a tax cut may increase the incomes of household which lead to increase in the disposable income. Moreover, increase in disposable income increases the consumers spending on foods and other goods that are needed in the family. Consequently, the level of demand in the country increases and triggers more production of goods and services. Therefore, a tax cut has an ultimate function of increasing production and consumption in the country. This in turn improves the gross domestic products because the country gains through production and commerce. On the other hand, a tax cut reduces the cost of production of firm thus making the production process more efficient than before the tax cut. Therefore, firm are left with the capacity to produce more goods or retain the cut as the profit of the firm. Increases production will ensure that firms meet the demand in the market as a result of increased disposable income (Dahlby 2008). Moreover, a cut that increases the profitability of firms make it possible to invest more capital on new technology thus boosting the countries production capability in the long run. Lower direct tax on firms will encourage investment in the UK from local and foreign investors. Tax break increases incentives that attract investment for businessmen and improves the labor productivity which consequently lead to higher living standards (Great Britain 2013). A lower tax assures investors of sustained growth as the costs of production are minimal. However, one of the costs of a tax cut on individual and firms is the reduction of government revenue. In the short run, the government will find it difficult to finance its expenditure unless its cuts on social program. Nevertheless, on the long run the economy will be better off with lower taxes than on high taxes. Question b (ii) The analysis of the tax cut on a micro level explains the behaviors of households and firms when there is a reduction in the rate of taxes on personal income and corporate tax. A direct tax cut on firms and individuals does not only increase income, but also has a substitution effect (Barro & Redlick). The increase in income may result to substitute increased income for leisure. Therefore, instead of household spending the extra income on expenditure they may result to cut on their hours in the job and substituting it for leisure or spending time with the family. A tax cut has the effect of increasing the income of an individual from Y to Y2. On the other hand, the same effect increased leisure time for the same cost of income; thus an individual would be willing to get income than spend time for leisure. This is the income effect of a tax cut. A direct tax cut makes individuals working hours valuable and thus increases the opportunity cost of leisure time (Smith & Grant 2003). The substitution effect encourages people to substitute time for work with time for leisure as shown in the above diagram (Smith & Grant 2003). Increase in income as a result of the tax cut shifts the indifference curve and steepens the budget line than it was before the tax cut. Moreover, this also happens to corporate organization. They substitute extra amount of income when tax is reduced by engaging in leisure for its work force and consequently boost the morale and productivity. Question b (iii) Taxation is an importance exercise that enables the government to finance its spending to provide essential and important, costly infrastructure to its citizens. Moreover, a reduction on the tax rate on individuals and industries enable the people to increase their consumption as a result of increased disposable income. Increase in consumption increases the demand of goods and services and thus triggers firms to produce more goods to meet the required demand in the market. . In addition, as the forces of demand and supply guides the market, firms produce goods at a lower costs as corporates taxes also decreases. The overall economic condition improves as the gross domestic product increases due to increased production and consumption. The debate for lower tax has concluded that lower income tax on corporate and individual increases the level of investment and economic growth. Empirical studies done in Canada from 2002-2006 confirm that cutting taxes benefit the country more than the decreased amount of revenue the government forego through the implementation of this program. Moreover, econometric analysis has shown that an economy that has lower taxes has accelerated economic growth. Therefore, cutting taxes in this period when the UK is recovering from the 2007-2008 financial crisis will facilitate fully recovery soon than later. In addition, decrease in tax rate has no costs that can affect the economy negatively and thus countries ought not to fear decreasing income and corporate taxes. References Barro, R and Redlick, C, Macroeconomics Effects From Government Purchases and Taxes, The Quarterly Journal of Economics, retrieved 05 April 2014, . Carraro, C and Siniscalco, D 1993, The European Carbon Tax: An Economic Assessment, Springer, London. Dahlby, B and Ferede, E 2008, Assessing British Columbia’s Incentive-Based Tax Cuts, The Fraser Institute, Antonio. Great Britain 2013, HM Treasury: Autumn Statement 2013-Cm. 8747, Stationery Office Limited, London. Smith, D and Grant, S 2003, UK Current Economic Policy, Heinemann, London. The Principles of Taxation, retrieved 05 April 2014, < http://homepages.uel.ac.uk/K.Bain/tax1.pdf>. Read More