Taxes Taxation and Recession Taxation

Taxes

TAXATION and RECESSION

Taxation and recession are closely linked and are quite directly proportional. If taxes increase rapidly, recession can approach just as fast. This has happened many times during the last few decades in American economy and people have seen how increased taxes set in a recession. Similarly decrease in taxes can stop recession from coming or halt it in its tracks. We have witnessed both and it clearly indicates that taxation is directly linked with recession.

Now we need to understand why that happens. Why is recession so closely connected with taxation and vice versa? When taxes increase, it means there is a proportionate decrease in people's income. The disposable income that people would normally spend on goods and services shrinks because of taxes and now they are spending lower on the products in the market. With less money at their disposal, the demand for goods and services also decreases. This leads to diminished-economic-activity since production and consumption both fall. "Most economists now acknowledge that punitive marginal income tax rates of 90 or 70 or 50% can stifle economic activity and growth. Indeed, a wealth of economic literature on the subject of taxes and economic growth now verifies that contention." (Dunkelberg and Skorburg, 1991)

But if taxes are really so bad, why are they ever raised? Government needs money for a variety of projects or simply to run the system. This money comes from the ventures in which government has a major investment. In order to start more such projects, government needs money and this is raised with the help of taxes. Now one point of argument that arises here is this: if the government is starting new projects, shouldn't that increase economy activity. The answer is Yes and no. Yes, if the money collected by the government is put to good use and projects are started and run efficiently than economy may actually get better. More taxes may also induce more savings and less consumption. However when project money is used inefficiently, then it only adds to the economic problems of the country. "If the resources allocated to the government are used inefficiently, or less efficiently than in private hands, economic growth is diminished and production falls. If additional tax dollars are used for a project that makes no contribution to productive capacity, and if the tax dollars raised prevent some private expenditure or investment that would have provided output and jobs in future years, growth is diminished." (Dunkelberg and Skorburg, 1991)