Many people advocate taxing "the rich" to alleviate the debt problem but the truth is that taxes will have to be increased on all income earners. What macroeconomic impacts would you expect to see...

Many people advocate taxing "the rich" to alleviate the debt problem but the truth is that taxes will have to be increased on all income earners. What macroeconomic impacts would you expect to see if taxes are raised "across the board"?

Asked on by sj83

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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First of all, it is not at all clear that the “truth” is that taxes will need to be raised on all earners.  In the current political climate, it is just as likely that taxes will not be raised on anyone.  That said, let us look at possible effects of a tax increase on all taxpayers.

It is not possible to know for sure how a tax increase will affect the macroeconomy.  Basic economic analysis would tend to indicate that a tax increase would decrease aggregate demand.  From this point of view, people would have less money to spend and therefore aggregate demand would decrease.  This would, all other things being equal, lead to lower GDP and higher unemployment.  The degree to which GDP would drop would be determined by the size of the tax increase and the size of the tax multiplier.

It is also possible that the tax increase would have an even greater negative impact on the economy.  It could be that the tax increase would decrease consumer confidence as people become even more worried about the economy.  This would decrease the marginal propensity to consume.  A change in the marginal propensity to consume would increase the size of the tax multiplier, thus making the impact of the tax increases even greater.

However, we can argue that the tax increase would help the macroeconomy.  If taxes rose and the government’s finances became more stable, people might become more confident.  They might think that the economy was going to become more stable and more predictable.  If confidence were to increase, businesses might start to invest more.  This would mitigate the decline in aggregate demand and could cause an increase in aggregate supply.  This might end up causing economic growth.

Thus, it is impossible to know what effect a tax increase would have because we do not know what its psychological impact on the populace would be.

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