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How can tax incidences have a positive and negative impact on the economy?

How can tax incidences have a positive and negative impact on the economy?
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Answer #1

The final or ultimate money burden of a tax is called incidence. It is the money burden of a tax which is borne by the last person. In short the incidence of a tax is the final resting place of a tax. Due to the shifting of tax, the impact of the tax may be on one person and its incidence will be on the other. The impact is the initial phenomenon and the incidence is the final result. Impact is the immediate burden of a tax on the person who first bears the legal obligation of a tax.

The incidence or final money burden of a tax has several economic effects on production, consumption, saving, investment, growth, regional balance, distribution of income and wealth and exchange. Some of these effects may be positive while others are negative.

Positive impact.

1. The money burden of tax in certain areas leads to the beneficial allocation of resources from undesirable uses to most desirable ones. For example the incidence of tax on luxuries, liquors, tobacco etc divert resources from their production to the production of necessities.

2. Distributive justice is one of the macroeconomic goals of the government. The distributive justice implies that growth in the economy should be shared equally by all sections of the people. Thus the tax incidence on the rich sections of the economy reduces the inequality in the distribution of income and wealth since more income is taken away from the rich person and given to the poor.

3. The increased tax burden increases the resources available for government for the purpose of expenditure. The ability to work, save and invest may increase in higher proportion of public spending than that they are reduced by tax burden.

4. The imposition of tax and its incidence can be justified on the ground that it is an important tool to control inflation and deflation. The incidence created by the imposition of new tax or the increase in existing tax during inflation would check the consumption and reduce the effective demand and thus helpful in curbing inflation.

5. The incidence of taxation on the rich people can be recommended on the ground that the burden of tax does not reduce their incentive to work. The effect of an additional burden of a tax is insignificant to the rich. Thus an incidence created by the imposition of tax on rich people is effective in mobilizing resource for public expenditure without having adverse effect.

Negative Impact.

1. When the tax burden falls upon the poor, it curbs the consumption of necessaries and comforts which lowers their standard of living. Thus the ability to work of the poor people is adversely affected by the money burden of a tax imposition.

2. The tax burden reduces the ability to save. The rich persons have ability to save than the poor. The money burden of tax on rich will reduce their ability to save.

3. The burden of a tax also reduces the ability to invest. Since saving is the source of investment, impositions of tax on rich who have ability to save reduce the availability of saving for investment. Thus investment in the economy decreases.

4. The tax burden on corporate firms reduces the incentive to invest and the overall reduction in income, output and employment.

5. The burden of tax on articles of mass consumption may not be socially desirable. As a result of increase in prices of such articles, the demand will decrease which will in turn reduce the production.

6. Heavy tax incidence on industries in rural and backward area will retards the growth of such areas.

7. The tax incidence of domestic industries will bring about shifting of domestic resources to foreign countries where the burden of tax is minimal. Thus resources are shifted from high tax countries to low tax countries.

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