Taxes can affect the economy in a number of ways ranging from national and local economic growth to how individuals manage their personal finances. Although taxation itself is ubiquitous, whether taxes have a positive or negative effect on the general economic condition of the country is the subject of much debate.
One of the main ways taxes affect the economy is by potentially helping to foster economic growth, primarily defined as job creation, business creation or anything that increases the level of services or goods a community or state provides. For example, federal taxes are allocated to different states that may be able to use those funds to help start small, local businesses or hire public employees.
It may seem as though more taxes create more opportunity for economic growth, but as National Center on Policy Analysis explains, it is not quite that simple.
“In any economy, there is an optimal tax rate (the percentage of GDP that comes from taxes) which will ensure maximum economic growth; if the tax burden exceeds that level, economic growth will slow,” the NCPA explains in “Do Taxes Affect Economic Growth?” If taxes are too high, people will take pains to avoid paying them and the national economy, measured by the Gross National Product (GDP), will not expand as much.
Tax Cut Pros
Tax cuts are a subject of heated debate when it comes to how they affect the economy. On the one hand, if people pay less taxes out of their paycheck (the primary method of tax collection by governments) they have more disposable income which they will use to stimulate businesses and services, thus having a positive impact on the economy. In fact, tax cuts have been credited with getting the country out of a recession on several occasions, according to Investopedia.com.
Tax Cut Cons
However, as Richard Cloutier writes in Investopedia.com's “Do Tax Cuts Stimulate the Economy?” tax cuts also mean the federal government is receiving less money, and this can ultimately create a federal deficit.
Regardless of how one feels about various tax issues, it is undeniable that taxes will affect the economy on every level--from the national GDP to how much extra money a family of four has at the end of the month after paying bills. Due to incredibly complex tax laws that encompass deductions, different tax thresholds, the ability of the wealthy to "shelter" income from taxation and a myriad of other factors, the direct impact of taxation on economic conditions can be difficult to assess.