How Taxes Affect Economic Efficiency Essay Example | Topics and Well Written Essays - 1500 words

How Taxes Affect Economic Efficiency - Essay Example According to Keynesians, tax cuts have a negative impact on the growth of wages (Ryan, 2011). There are some countries where governments encourage international trade while on the other side, some raise barriers. Some governments impose just enough tax to support various government expenditures while some levy taxes which burden the whole population (Kroeger, 2011). Adam Smith is revered in the field of economics because of his remarkable work on free-market economics and taxation. There are many economists of the modern times who consider Adam Smith the best tax economist of all time. According to Smith, the resources of a nation are allocated in the most efficient manner through an 'invisible hand'. According to Smith's view, taxes should be levied in such a way that they optimize and satisfy four variables. These variables include equity, transparency, convenience, and efficiency. According to Smith, by imposing limited taxes, economies can maximize their wealth (Kroeger, 2011). T axes are imposed by a government to support some basic functions. These legitimate functions include education, defense, and the construction as well as maintenance of roads. In a market economy, the allocation of resources depends on the forces of demand and supply. In order to understand the ultimate impact of tax on economics, it is imperative to evaluate this impact in terms of the purchasing power of individuals as well as the economy's aggregate supply. One of the basic concepts of economics is that an increase in demand leads to the production of more goods and services in order to fulfill the demand. It implies that if producers can sell more because of an increase in demand of their products then they need to produce more goods to satiate the increasing demand. The imposition of tax deprives tax payers from a portion of their money that they would have spend on consumption. If it is accepted that the imposition of tax only deprives people from money than it would be conclud ed that taxes have a negative impact on economy. However, by looking at the other side of coin, it can be comprehended that the money which people spend on taxes eventually turns into government's income. Government spends this money on the welfare of the public which in turns enhance the economic growth (Kroeger, 2011). The income of one person depends on the spending of others. When government spends the money, it ultimately turns into the income of the public. Similarly, when the public pays taxes, it becomes the income of the government. So, it is wrong to say that the imposition of taxes drops the aggregate spending in fact it causes it to increase. If tax payers save their money instead of paying taxes, it will impact government expenditures and will decrease the overall consumption and in turn the overall economic efficiency. Similarly, if government saves money and does not spend it then it would ultimately affect the public. It proves that the act of saving money is not ben eficial for the overall economy of a country but it creates problems. This act is really harmful for the economy of the country. A very obvious example of the harmful effects of this act is the Great Depression. The Great Depression occurs because people who could have opted for spending money chose to save it. However, those who wanted to spend money were deprived of it (Kroeger 2011). The long term expenditures of government increase with the growth of population. Therefore government needs money to