Taxes and Economy: Growth vs Development

Do you think that the economy is doing well if it has a reasonable level of GDP growth rate and tax collections? Think again.

From the point of view of economics, income tax rates have not been found to have a consistent correlation with GDP growth rates. However, basic microeconomic theory does suggest that increase in tax adds to the burden on price of goods and services. This burden falls unequally on both consumers and producers depending upon how responsive the demand for that particular good or service is in existing markets.

This happens because such a price increase is artificial and extraneous to market force analysis and results in a net contraction in demand. There is therefore a loss in revenue that could have been generated had buyers and sellers been free to determine the market price according to prevailing cost of inputs and the willingness of the consumer to pay for an extra unit of the product.

In short, tax increases are bad for everybody and should not be implemented unless there are compelling reasons to do so.

To further clarify the function of economic growth and fiscal policy it is necessary to clarify what is meant by the former and how it differs from economic development.

Economic Growth: The GDP or the Gross Domestic Product is a measure of the total income earned by all wage earners, business owners, holders of titles to property, speculators investing capital in commercial ventures and so on. Alternatively, it can also be computed as the monetary value of all goods and services produced in a country in one single financial year.

The quantity that is pertinent to the term sought to be defined is the rate of increase in GDP compared to the previous year expressed in percentage terms.

Economic Development: While the previous term assumes that increase in income growth, though unequally distributed, will trickle down to the lowest strata of society in the long run, the Human Development Index – a composite measure of education, life expectancy and per capita income measures changes in the condition of the human self as a result of economic action.

Neither of these are complete nor perfect indicators and we leave it to the gentle reader to decide the meaning of each term the next time you read the Annual Budget or do your income tax returns.

This information is provided to you in the public interest courtesy of AllIndiaITR, a product of Corwhite Solutions Private Limited.