The most important objective of taxation is to raise required revenues to meet expendi­tures. Apart from raising revenue, taxes are considered as instruments of control and regulation with the aim of influencing the pattern of consumption, production and distribution. Taxes thus affect an economy in various ways, although the effects of taxes may not necessarily be good. There are same bad effects of taxes too.

Effects of Taxation on Production:

Taxation can influence production and growth. Such effects on production are analysed under three heads:

(i) effects on the ability to work, save and invest

(ii) effects on the will to work, save and invest

(iii) effects on the allocation of resources.

Effects on the Ability to Work Save:

Imposition of taxes results in the reduction of disposable income of the taxpayers. This will reduce their expenditure on necessaries which are required to be consumed for the sake of improving efficiency. As efficiency suffers ability to work declines. This ultimately adversely affects savings and investment. However, this happens in the case of poor persons. Taxation on rich persons has the least effect on the efficiency and ability to work. Not all taxes, however, have adverse effects on the ability to work. There are some harmful goods, such as cigarettes, whose consumption has to be reduced to increase ability to work. That is why high rate of taxes are often imposed on such harmful goods to curb their consumption.

A Raising of Prices:

The imposition of or increasing the rates of indirect taxes will cause the prices of the taxed goods to rise. Increases in indirect taxes, therefore, have implications for a government’s policy in relation to inflation. Such increases can have adverse effects on the rate of inflation not only directly, via increased prices, but also indirectly, via increased wage demands made by workers due to rise in their cost of living.

A Reduction of Enterprise:

Entrepreneurs undertake investment in anticipation of increasing profit. Investment projects may be risky so the expectation of large profits is an important incentive. If, however, profits are heavily taxed, the entrepreneurs may feel that it is not worth taking such risks and so they will be far more cautious in their attitudes. Such caution may lead to reduced progress and efficiency with a consequent deteriora­tion in the ability of domestic producers to complete with foreign rivals. Incidence of Taxation

A Redistribution of Income:

This effect is felt most in developing countries. A proportional tax will not affect the distribution of income, but both progressive and regressive taxes will cause a change in income distri­bution. With progressive taxes, the post-tax distribution of income is more equal than the pre-tax distribution, whereas with regressive taxes the post- tax distribution is more unequal than the pre-tax distribution.

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