The Economic Effects of Raised Taxes

by Gregory Hamel ; Updated July 27, 2017

Taxes are financial levies and fees imposed on people by a governing body to raise revenue so that the body can finance its debt and fund its programs. Taxation is an important issue in the field of economics. Taxation is often considered an inefficient practice for promoting optimum economic activity. There are several possible impacts that tax increases can have on an economy.

Decreasing Consumer Spending

Consumer spending is often considered one of the most important signs of economic health in the United States (U.S.). When consumers are buying goods and services, businesses make profits and may expand, which can further create economic activity. When taxes increase, consumers may have less money to spend on discretionary purchases, which can cause overall consumption to fall. This can, in turn, cause economic growth (often measured by the rate of increase of gross domestic product or GDP) to slow or may even cause the economy to shrink. Reducing taxes, on the other hand, is a common tactic the government uses to spur economic growth. One of the arguments against raising taxes is that the negative effect it can have on economic activity means that it could shrink the tax base, ultimately resulting in less taxes raised, even at a higher tax rate. For instance, if a state raises sales taxes to bring in more income, but it causes consumers to reduce spending, the change might not increase the total revenue brought in by the sales tax.

Employment

Tax increases can put negative pressure on employment. When individuals and businesses are taxed more, spending and profits can fall, which means businesses may need to make budget cuts. One of the easiest ways to cut budgets is to lay off employees. When taxes are reduced, it can increase revenue, which may enable businesses to have enough money left over to keep employees or even hire new employees.

Investment

Increased taxes can put negative pressure on investment. When taxes are increased, businesses may have a more difficult time making profits, which can cause investors to pull out of the market after a tax hike. Since tax increases often slow GDP growth, it can also cause the stock market to dip. Another way tax increases can affect investment is that, with higher taxes, individuals will simply have less money to invest. For instance, the wealthy tend to invest a large proportion of their money in the stock market. So if taxes are increased on the wealthy, the tax money could directly reduce the amount they can invest.

About the Author

Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.