Introduction
Taxes normally decrease the amount of wage the employees take home. In most situations the taxation effects are evident, for instance payroll and income taxes are deducted from employees’ pay checks (Ziliak, 2005). Sales tax or Value Added Tax (VAT) affects the employee’s income indirectly compared with payroll and income taxes, even so they are similar. Sales taxes normally increase the prices of commodities that the consumers buy lowering the labour income’s purchasing power. Therefore, whether sales, payroll or income are taxed by the government, any employee’s hour worked enables him/her to consume less than he/she would consume if there were no taxes. This problem has been considered most exhaustive in the perspective of the income taxation.
The major issue to consider in this case is to determine whether taxes decrease the amount employees are ready to work for. There is no definite answer given by the economic theory. Reason being that decreasing employee’s wage income through taxes is expected to pull them in two diverse directions. An employee can be demoralized and work for few hours if he earns lower wage after deduction of taxes as it is worthwhile to spend his time pursuing leisure activities, or in carrying out non-market activities like home production, which are not imposed any tax. This inclination, termed as substitution effect, reduces the employees’ work effort (Ziliak, 2005: Riley, 2006: Smith, 2011).
Nevertheless, a lower wage after-tax may make an employee to work for many hours because every hour worked enables one to consume less goods than when income were not imposed taxes. This type of tendency is normally referred as income effect and it has an opposite effect. For instance, in case income effect is not stronger than substitution effect, any taxation imposed on the employees’ wage will lower the effort being put by the worker; but when the two have the same strength, the net consequence or effect of imposing taxes on the income might be unchanged work effort (Ziliak, 2005).
Taxes may not alter the hours worked but they still make a difference between before and after tax wage received by the employees, leading to a distortion in an employee’s labour supply which is a possible additional burden, or taxation cost efficiency. The distortion size usually depends on substitution effect’s size. Therefore, if an employee with “lower” substitution effect which is offset by “lower” income effect is taxed, the tax does not change the labour supply and thus has lower efficiency cost. Conversely, income taxes on employees with “huge” substitution effect which is offset by “huge” income effect may have huge cost efficiency, even if employee’s labour supply remain unchanged (Ziliak, 2005).
Studies by Killingsworth in 1983 and Pencavel in 1986 as cited by Ziliak (2005) showed that the labour supply, particularly of households headed by men, was reasonably unresponsive to variances in after-tax income. They found out that people have comparatively “little” inclination to substitute hours for leisure with work when wage reduces is counteracted by the same inclination to work for many hours as a result of lower income after tax deduction. Thus the findings were used as a foundation for uneven consensus that variations in taxes were expected to have small or no impact on the labour supply.
Taxes
In a system of progressive tax, the more the income one earns the more tax one pays, meaning that one pays tax according to the proportion of income earned. Conversely, regressive tax requires one to pay more tax as income decreases. Thus, the two tax systems are different in that in regressive tax, the average tax reduces as wage increases whereas in the progressive tax, the average tax increases as wage increases (Slemrod, 2002: Kennan, 2011). The two systems have immensely diverse effects on various income groups. For instance, richer people will be affected more by the progressive taxes, because those with higher salary will pay more taxes at a higher tax rate. While, the lower income earners will be affected more by the regressive taxes, because they will pay more taxes (VAT) when they consume goods and their little salary will have to be taxed. Progressive taxes are normally used in income, and as income increases a huge proportion of it is used to pay tax (Slemrod, 2002). This leads to demoralization among citizens, but this is eventually fairer to employees earning low income since progressive tax also promotes income redistribution.
Regressive taxes on the other hand, are indirect in nature and take a huge percentage of the salary as income decreases because it is imposed on goods purchased. For instance, assume two consumers, A and B, earn £200 and £1,000 respectively, and both of them spend $5 in a glossary store, regressive tax (VAT) would take 2.5% of A’s income and 0.5% of B’s income. Thus regressive taxes have potential benefits of decreasing the expenditure of the demerit goods, but might in reality lead to widening the income gap leading to inequality since it discourages redistribution (Kennan, 2011).
Utilitarian principles propose that tax burdens must be allocated to capitalize on social welfare. Francis Edgeworth, a 19th century economist, indicated that if the society perceive one dollar to be valueless as income increases, then to maximize the society welfare through a tax system which equalized all incomes, the government must impose taxes on all income more than a specific level and allocate proceeds to the one with income below the cut-off income. The issue in such a case is that equalizing system of tax would reduce motivation to work, innovate, invest and save, in order that the national pie’s size that is to be distributed evenly would rapidly get smaller (Slemrod, 2002).
Keynesian Theory
Keynesian economics contend that decisions of private sector at times result to ineffective macroeconomic results and thus promote active responses by public sector through fiscal and monetary policy in order to stabilize the economy (Rhodes, 2003). The Keynesian economics are founded on the “General Theory of Employment” and “interest and money” (Rhodes, 2003). Keynes advocated government intervention in periods of economic crisis. In his “General Theory”, he contended that countries are constantly unstable and full employment can be achieved through a government policy boost as well as public investment (Rhodes, 2003). He deemed that the government was responsible for bridging the gap between country’s capability and its real output throughout the economic crisis, even though debt is employed (Rhodes, 2003).
In Keynes’ perspective when the “major economic pillars are falling, investment, net exports and consumption, this leaves the government as the only pillar to sustain the economy” (Bowman, 2009). Whereas Keynesian ideas might hold control over the policymakers on the two sides of the aisle, sceptics state that “particular policy advance like the stimulus package used by the Obama administration is off-base” (Bowman, 2009).
The fiscal policy can control the aggregate demand, leading to price stability, economic growth and full employment. Keynesian economics proposes that raising government expenditure and reducing rates of taxes would encourage aggregate demand, as well as reduce expenditure and raise taxes’ after the start of economic boom. Increasing government expenditure and tax reductions are seen by Keynes as tools that are vital in expanding the economic growth and are only applicable in recession or when faced with stagnant economic growth (Arthur and Sheffrin, 2003). Theoretically, any deficits would be amortized by expanded economy that would take place following the boom (Arthur and Sheffrin, 2003).
The theory of Keynesian hypothesizes that getting rid of government expenditure would decrease aggregate demand levels and shrink the economy therefore stabilizing prices (Riedl, 2010). Finally, proponents of Keynesian theory argue that consumption contributes to “direct growth of the economy whereas money saved does not” (Riedl, 2010). In this perspective, food stamps, unemployment benefits as well as low-income tax reimbursements are amongst the key efficient stimulus policies since they have a possibility of being consumed as opposed to being saved (Riedl, 2010).
Limitations
Economy stimulus using fiscal policy could activate production, increase wages, labour demand and hurt profitability. Secondly, use of deficit would increase government bonds’ stock, decrease bond’s market price as well as encourage increase in interest rates, leading to increase in price for finances like debt. Therefore, the stimulus effort as advocated by Keynesian would fail to encourage growth in the economy.
If government expenditure is funded from present taxation of profits, capitalists in general will be making payment to the country or country’s dependants to acquire their goods. This leads to decrease in profits for social capital as well as reduced inducement in manufacture of goods. Stimulation of any kind to any corporation will not be offset by depressive taxation effects on business corporations in general. Thus, increasing government expenditure financed through present taxation will, ‘ceteris paribus’, not lead to growth but stagnation (WordPress.com, 2011).
In addition, expanded deficit expenditure may not encourage expenditure in general, because expanded government borrowing would precisely be counterbalanced by decreased private spending and borrowing. This view only applies in times of boom and not depression. During depression, resources are not fully employed, including cash in banks. But Keynesians deem that if the country’s has less supply of money, the government should print extra money provided that there are productive workers and forces not employed, which is not true in a monetary policy perspective (Markwell, 2006).
Nevertheless, deficit expenditure is not a remedy to economic growth as Keynesians believe, because it simply delay taxation increase as debts or interest have to be repaid to the bondholders. This leads to a problem in that money used to repay debts to wealthy owners increases at expense of what unemployed population enjoy. Thus, the more engagements in deficit expenditure in depression times, the superior the public debt burden (Akerlof, 2007).
Even though deficit expenditure does not increase interest rates in long-term during depression, it does raise outstanding debt which exists on money market at times when recovery of the economy sets in. This leads to increase in interest rates earlier as well as faster than if debt did not exist. It also cut down the boom and increase unemployment in the following boom. The depression is normally shortened if it starts after crisis-recession has bottomed-out. In such a case, the intensive crisis will not be reduced but if the government intentionally raises deficit expenditure at the time of crisis, it normally risks increasing the crisis as it precisely what took place in 2007-09’s crisis (WordPress.com, 2011).
In 2007, Bush administration negotiated for a “stimulus plan” to pump in $168,000 million through tax repayment, which was to be financed by expanded government borrowing (WordPress.com, 2011). The borrowing was put in credit markets, which were already rolling from emerging crisis. After the collapse of the Lehman Brothers the financial panic intensified as a result of expanded federal borrowing leading to purchasing power and credit contraction that transformed to Great Recession. This shows that Keynesian economics can sometimes fail. Nevertheless, if more deficit expenditure does not really strengthen crisis like in 2008, it may increase depression-stagnation phase duration that follows the financial crisis like the World War II when the policy was applied (WordPress.com, 2011).
Infrastructure
Infrastructure needs for any economy are very high, costs are abnormally low, and citizens need jobs. Additionally, spending in infrastructure such as High speed (HS2) rail link, improves future growth of the economy and it can be viewed as supply-side policy. Government expenditure on infrastructure is in line with Keynesian theory since government should spend in order to increase economic growth as well as create employment in the country. Infrastructure helps the country to achieve economic growth, which means that economy and infrastructure are related; thus, investing in them benefits the citizens and the economy at large (Rhodes, 2003). If the rail is constructed efficiently, it will make firms to be more competitive, thus lowering firms’ cost of production, which is like tax cut.
Infrastructure investments assist the firms together with the citizens to save important resources like money and their time (Rhodes, 2003). Keynes deemed that the government was responsible for bridging the gap between country’s capability and its real output and spending on rail supplies public goods that boost the economy through efficient transport system leading to improved growth (Rhodes, 2003: Thoma, 2011).
Unemployment is an economical issue facing the country; this means that the government’s policies should be channelled towards reducing it (Rhodes, 2003). Additionally, infrastructure investments will put many citizens to work and with many construction employees presently unemployed it is now the correct time to carry out infrastructure investments (Thoma, 2011).
Considering that the economy is recovering from the recession which brought with it high unemployment. A huge proportion of jobs are created through infrastructure investments leading to creation of occupations in manufacturing, retail trade and construction that were hit hardest by recession. These three sectors normally pay middle-class wages, thus employment in such sectors strengthen middle-class jobs (Kao et al, 2010).
However, the government is faced with a decision to determine which sector, private or public, should construct the rail. Considering that the government may not have advanced technology, managerial skills and attention, and additional needs for modernity, quality and cost reduction, it may have to contract private sector to carry out the job. Therefore, this leads to increased employment, as a result of involvement of the private sector which eventually improves economic growth.
Conserving the environment, particularly at this time of global warming, during construction as well as operation of the systems of infrastructure is an ever more challenging issue. Many environmental concerns in the past have focused mostly on highway projects, and sewage systems among others, with the difference broadening to take in hospital expansion, and school sites among others.
Environmental concerns concentrate on land, water and air and it entails concerns for species retention and human health in addition to aspects of history, culture and history (Answers Corp Partner, 2006). Differences arise over utilization of the non-renewable energy for operations of infrastructure as well as sustainability of the given metropolitan area. And this may create a problem for the rail construction which raises discussions preventing economic growth.
References
Answers Corp Partner: Gale Encyclopaedia of US History: Infrastructure, 2006. Web.
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Bowman, Q. 2009. Keynes’ economic theories re-emerged in government intervention policies, Web.
Kao, T., Yung-Cheng, L, and Shih, M. 2010. Privatization Versus Public Works for High Speed Rail Projects. Transportation Research Record: Journal of the Transportation Research Board, 2159: (18-26).
Kennan, M. 2011. Examples of progressive tax, Web.
Markwell, D. 2006. John Maynard Keynes and International Relations: Economic Paths to War and Peace, New York. Oxford University Press.
Rhodes, C. 2003. What is Keynesian economics? Web.
Riedl, B. 2010. Why government spending does not stimulate economic growth: answering the critics. The Wall Street Journal, Web.
Riley, G. 2006. Supply of Labour to Markets, Web.
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Smith, K. 2011. Do taxes decrease the incentive to work? Web.
Thoma, M. 2011. Category Archive for fiscal policy: Shovel ready, Web.
WordPress.com: A critique of crisis theory: From a Marxist perspective, 2011. Web.
Ziliak, J. 2005. The effect of taxation on income and what circumstances workers may choose not to work at all or not to work longer hours, The Urban Institute, Washington DC.