The debate on taxation and economic growth is a perennial one. Proponents of higher taxes frequently point to the ballooning deficit as an example of why such taxation is necessary. They further argue that without higher taxation, the government will fail to distribute its resources in a timely manner leaving the citizenry frustrated and disillusioned. The other side of the argument points to the poor performance of many countries in the past and current periods, namely Greece and Spain. Both of these countries have seen major declines in their respective economic performances over the past decade, and many believe these are the result of poorly managed political systems.
As is typically the case when considering such debates, there is little actual agreement between the two sides of this debate as to whether or not taxation is actually good for an economy. A balanced argument can be made in favor of higher taxes as a means to ensuring greater economic growth, although the actual results vary widely from one polity to the next. While some governments have raised taxes on specific sectors of their society, most have not, while others have implemented regressive taxation with regard to income levels.
In terms of the role of taxation in encouraging economic growth, most experts agree that a combination of higher taxation and economic development is the best strategy to use in creating an environment that will allow for long term success. Whether or not the method of distribution is a flat tax or a wealth tax, it is believed that the distribution should be broad enough to cover all sources of income within a society. This ensures that people are not punished for the bad acts of a few, but that everybody has a fair share of the pie.
But just how effective is taxation in promoting economic growth? Some experts point to the fact that the tax system in many countries around the world has actually led to slower economic growth than would have been possible without it. Others point out that the wealth of countries like the United States is more evenly distributed than ever before, providing a better platform for economic advancement. Both groups generally agree that taxation should be used to reduce income disparity within a society, as well as to provide opportunities to those who may have previously been denied them. Unfortunately, some forms of taxation are viewed as a form of wealth protection. For example, some tax schemes limit eligibility for income tax by limiting the amount of taxation an individual or family can earn on their wealth.
While taxation can and does have a place in encouraging economic progress, it is important to remember that taxation should neither be seen as a means to avoid taxation nor an excuse for poor performance by the government. The first goal of taxation is to ensure that the revenue created is sufficient to support public services and programs. The second goal, of course, is to ensure that the tax base is maintained. The level of taxation should neither be too low as a means of revenue generation, nor too high as a way of transferring wealth to the government or other individuals.
While taxation can have an indirect effect on economic growth, there are two main ways in which it can directly affect economic development. First, direct taxation means charging taxes on products and services that have either been purchased or consumed and include income and estate taxes, sales taxes, and value-added taxes. The second type of indirect effect is indirect taxation through subsidies. Subsidies may be provided to businesses or other entities in order to increase production, infrastructure, research and development, employment, or to develop new services or products. These programs are often called soft Walls, as they typically impact markets in areas of concentrated . . . . . . unemployment, poverty, and lack of investment capital. Subsidies have been shown to significantly reduce poverty, improve public health, and encourage investment.
While taxation can and does have an indirect effect on overall economic growth, it can also work in the opposite way. The rate at which a nation extracts tax revenue from the production, saving, and consumption of its citizens is called a negative cost curve. In short, this means that taxation can actually reduce a nation's growth rates over time. For example, if a nation increases taxation on firms that produce energy, the resulting reduction in demand for energy will lead to a decline in energy prices, and a drop in the amount of energy available. In addition, some forms of taxation can actually increase productivity. This is because the revenues generated by such measures enable tax dollars to be used to make investments in new goods, services, and technology.
Although taxation can have both positive and negative effects on overall economic growth, those effects can generally be offset by higher output, more efficient means of producing economic goods and services, and increased entrepreneurial activity. Because taxation affects people in all walks of life, it is not only a necessary part of a healthy economy; it is a must for survival. So, when debating the merits of taxation and economic growth, the most important question to ask is not “Should taxation and economic growth be done separately?”