Economic Effects of Taxation

I. Effects of Taxation on Production

The most important objective of taxation is to gather revenues to fund public expenditure but this is not the sole motive of taxation. Apart from public expenditure, taxation is used as an instrument to control and regulate the money supply and private expenditure as per the economic environment, to affect the pattern of consumption, production, and distribution. Taxes thus affect an economy in several ways, and it is not necessarily important that the effects of taxes may always be positive on the economy. So, the effect of taxation can be studied under three major heads:

Effects of Taxation on Production
Effects of Taxation on Distribution
Other Effects of Taxation

Economic Effects of Taxation

Taxes are defined as the basic source of revenue for the government and can be described as the money that people are required to pay to the government, and government deploys these inflows in public service and helps the economy move at a pace. It is a burden laid upon the citizens for the income they earn or the assets they hold, tax is not a voluntary contribution to fund public service rather it is an enforced contribution directed by law. Taxation is levied by government bodies to incur common welfare expenses for society and to meet expenses related to Defense, Medical infrastructure, Road connectivity, Education, etc. It is the Indian constitution from which the government derives power to levy and collect taxes. Moreover, taxes can be of two types i.e.

Direct Taxes: In case when the tax is levied directly on the personal income earned by the person or the personal assets held by the person then such tax is called a direct tax, i.e. where the burden of tax is directly on the person who incurs any earning or profits. Examples are Income Tax, Corporate Tax, etc.
Indirect Taxes: In cases when the tax levied on the price of goods or services which is consumed by the person. Here, the incidence of tax keeps shifting from one person to another till the goods or service reaches the final consumer. Examples are Goods and Service Tax (GST), Custom Duty, etc.

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