Effects of Taxation on Production and Distribution

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In today’s article we are going to know about Effects of Taxation on Production and Distribution (Effects of taxation on production or economic growth). So let’s discuss this.

Effects of Taxation on Production

Dalton has divided the effects of taxation on production into three parts-

• Efficiency of effects (Effect on ability to work, save and invest)

Heavy taxation reduce the purchasing power of the people who are completed to purchase lesser amount of goods and services. This reduce the standard of living of the people and bring down their ability to work. Taxation also effects people’s ability to save.

This is because saving depends upon the income of the tax payers. Heavy taxation reduce income level, less saving means low rate of capital formation which leads to fall in production. Ability to invest is also adversely affects it, the tax rate is very high..

• Incentive or disincentive effects ( effects on willingness to work save and invest)

Production is also influenced by the people’s willingness to work save and invest. Since willingness refers to the state of mind of a person. Therefore, it is not easy to tell accurately the exact nature of effects of taxation on the willing to work, save and invest.

Heavy taxation affects the desire to work hard. On the other hand, when the tax rate is nominal then the desire to work hard increases. Thus it is related to the psychological reaction of the tax payers.

• Allocation effect (Effect on the diversion of resources to the different uses) 

Taxation is a powerful weapon to achieve rational allocation of resources. Resources can be diverted from undesirable uses to the desirable uses from social welfare point of view. The taxation diverts resources from developed areas to the backward areas.

In this way, taxation can help in achieving the objective of balance regional development. Tax on consumption encourage savings and thus the productive capacity of the country increases. On the other hand. it savings are taxed, the resources will be used for present consumption.

Effects of Taxation on Distribution

The taxation affects the distribution aspects in different ways. Normally, the distributive effect of taxation depends upon nature of taxes (Progressive, regressive or proportional) and kinds of taxes (Direct and indirect tax). The important distributive affects of taxation are given below-

• Reduction in inequalities

Taxation is considered as a powerful fiscal instrument to reduce inequality in the distribution of income and wealth. Progressive taxation is recognized as the best means of achieving fair distribution of income between rich and poor.

• Diverting the resources to the social services

Taxation has been recognized as an instrument for diverting the resources to the social services sector. In the welfare state, the govt undertakes social services to protect the interest of the poor sector.

As for example- Supply of drinking water, construction of road ways, etc. through taxation resource are directed from undesirable uses to social service sectors.

• Employment Generation

Heavy import duties on imported goods encourages domestic industries to produce such goods will have favourable effect on the distribution of income and generation of employment opportunities in home industries.

• Reduces undesirable consumption 

Through indirect taxes the govt wants to control undesirable consumption. Heavy taxation on harmful commodities  and luxury item (car, imported materials, etc.) diverts resources to the socially desirable sector by reducing their consumption and production.

• Controlling inflation

The taxation has different roles in times of inflation and deflation. In order to reduce the purchasing power of the people during inflation, tax rate should be increased.

In this case the role of the direct tax is very important. But it must be remembered that indirect taxation is not effective in controlling the inflation. (So friends it was Effects of Taxation on Production and Distribution).


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