IA (Eco) Impact of an increase in VAT

[chaoticmadness]

Hi! My article states that Slovenia decided to implement the increase in taxes on VAT (value added taxes) because these taxes have the least impact on economic growth. Can anyone explain why? I researching it and came out with nothing

Thanks a million

[-._._.-]

This is just my speculation:

If the government introduces income taxes employees may be discouraged to work hard. After all, if they work harder and they earn more money, it's going to be taxed anyway. This means that productivity does not increase and may even decrease. Corporate taxes work the same way. Company profits might not be used for investment to give even more profits because they will be taxed and firm owners would not gain the profit for themselves. So this is a disincentive for research and development and other forms of investment. This means that technological breakthroughs are less likely to happen and thus the PPC does not really shift outwards which is required for long run aggregate supply.

Okay let's try again. Economic growth is achieved by an increase in GDP. If the government introduces income taxes, employees may be discouraged from working too hard because they will be taxed anyway so they won't really get to reap the gains of working harder. Productivity does not increase and may even decrease. Assuming it decreases, firms gain less profits. They may choose to reduce their output. If corporate taxes are in place, the already decreased profits will be even less after tax. This is a disincentive for firms to hire more labour or to invest (this can also be in the form of research and development). These result in a decrease in SRAS, in addition to a decrease in LRAS.

Another way to look at it: With taxes, both income and corporate, disposable income decreases. So spending and thus GDP decreases.

Having said that, VAT, on the other hand, may still have a negative effect on economic growth. If VAT is imposed on inelastic goods then it makes our lives simpler as GDP will not decrease so much. In fact, the government now gains tax revenue in which it can spend (on areas of development like building roads in rural areas) which also increases GDP and thus economic growth.

But if the goods are elastic, then demand decrease, GDP decreases. The tax revenue can be used by the government to boost government spending, but consumer spending contributes most to GDP, so we have a net effect of a decrease in GDP. Which is still bad.

However, imposing VAT does not decrease SRAS. Income and corporate taxes do. So basically VAT has less of a negative impact on economic growth.

Someone else will have to verify everything I just said.

Edited June 13, 2013 by -._._.-

[Liliii]

Value Added Taxes are indirect taxes added to products on the price of purchase affecting consumers especially the poor but it doesn't affect the producers and so they won't vary their supply greatly to such an action and so not having an impact on economic growth. (This is on the short run)

[chaoticmadness]

Thank you!