Caleb Patel Real 100%Tax Revenue y2 AD2 Assess the economic effects of a Price LevelP2 Output y2 AD1 0 Price

0 Output 0 P1 AS Real Tax AD1 y1 Rate Level AS P1 P2 y1

significant increase in taxation on the UK economy A significant increase in taxation on the UK economy is likely to cause a decrease in aggregate demand. This is due to people having less disposable income from an increase of direct taxation and also goods and services becoming more expensive from an indirect taxation rise. Therefore there is a higher incentive to save money, and consumer confidence is lower, so aggregate demand decreases.

There is an inward shift in aggregate demand from AD1 to AD2, which also causes the equilibrium price level and real output to decrease from P1 to P2 and y1 to y2. However, the extent of this change in aggregate demand depends on the elasticity of the aggregate supply curve. If aggregate demand shifts inwards at an inelastic part of the aggregate supply curve, there will not be much difference in the changes of real output and price level on the economy. Therefore there may not be as big as an effect from an increase in taxation. Another effect of a significant increase in taxation on the economy is higher unemployment rates. A raise in income taxes will give people a disincentive to work, because they are losing a lot of what they are earning, and feel the income isnt worth working for. This would then lead to less output, as people have less motivation to work as efficiently, and firms become less productive. However, this all depends on what the taxation increase will have on peoples incomes. If incomes are rising, then the overall salary of workers wouldnt change as much with the tax rise. The prices of goods and services relative to the income tax rise also determines how much people are willing to spend, as if goods and services have a lower price whilst there is a rise in income tax there will be not as

Caleb Patel much disincentive to work, as they can afford to consume the same amount of goods and services. As the price level is affected by the inward shift in aggregate demand, inflation rates could be reduced as a result of the price levels decreasing. This low inflation could help improve the balance of payments deficit on current account, as exports are more attractive to other countries with lower prices. However, the original income tax increase could possibly lead to workers demanding higher wages, as their salary has been cut. These inflationary wage demands will make costs of production higher, as firms have to pay more to their workers, and therefore the goods or services produced will cost more, resulting in more inflation. This means inflation rates may not be reduced by much or at all. The significant increase in taxation is also likely to help reduce the budget deficit, and if it is more than the government spending, causes a fiscal surplus. This takes spending power out of the economy, leading to the negative multiplier effect. Therefore there will be less money circulating in the economy, and any inflationary pressures will be eased. As there is also a reduced deficit, there will be less or no need for borrowing money to fund government spending. However, people may begin to avoid paying tax if there is a too significant increase in the tax rate. The Laffer Curve shows that if people are having to pay at higher tax rates, they have less incentive to work, so unemployment rises. Therefore there is a decrease in tax revenue received by the government, as more people are avoiding paying tax. This will lead to the budget deficit remaining the same or not being reduced by that much due to less tax revenue than expected.

Caleb Patel

A significant increase in taxation is likely to have many effects on the UK economy like decreased aggregate demand, higher unemployment rates, reduced inflation and reduced budget deficit. However these effects may have much of an impact, as many factors are in play such as the elasticity of the supply curve, changes in incomes and incentives to work.