The government taxes businesses and individuals as a way to raise money for its expenditures, including defense, education, Social Security and Medicare. During budget shortfalls, raising taxes is usually accompanied with steep cuts in several programs. A July 2011 "Wall Street Journal" article explains how the debt ceiling debate in Congress hinges on a compromise between making cuts and raising taxes. too high or setting them too low has a noticeable effect on human behavior. Additionally, taxing certain items may affect behavior.
Types of Tax Policies
Different governments implement different systems of taxation. A progressive tax system taxes wealthier citizens at a higher percentage rate than citizens in a lower socioeconomic bracket. A regressive tax is the opposite -- poorer citizens are taxed higher than the rich. A flat tax system is when all citizens incur taxation at the same rate. The U.S. has a progressive income tax system; the Internal Revenue Service, or IRS, demands a higher percent of income for those earning above $200,000 than from those earning less than $25,000 per year.
Increase in Taxes
An increase in taxes causes a decrease in consumption as a result of less disposable income. The government recognizes that an increase in taxes often reduces the Gross Domestic Product, or GDP, on account of slowed consumer spending. If consumption slows, companies may issue layoffs. High unemployment in turn worsens the government's ability to raise revenue; the government may notice an increase in its unemployment and welfare expenses. At worst, a hike in taxes causes revolt. Riots occurred in the U.S. during the late 1700s as a result of Britain's exorbitant taxation of the colonies. An August 2011 "BusinessWeek" how Grecian citizens are rioting over the government's hike in taxes and cuts in public services programs.
Decrease in Taxes
A decrease in taxes increases consumer spending. When taxes are low, people have more money to buy a wide array of goods from televisions to homes. Sometimes, the government offers tax incentives in hopes of boosting consumption. The $8,000 tax rebate issued to first-time home buyers in 2009 is an example of this policy.
Considerations
Taxation on certain items may also cause changes in purchasing habits. A spike in gas prices causes many consumers to switch from SUVs to fuel-efficient alternatives. Likewise, increasing taxes on cigarettes causes some consumers to quit or seek alternatives like hookah. However, taxation does not always dissuade consumer behavior. New Mexico State University economics professor Chris Erickson explains increasing tax on alcohol and cigarettes has little effect on consumption; it might be beneficial for raising revenue, but not curtailing vices. Additionally, Erickson explains sin taxes serve as a form of regressive taxation -- the poor pay a greater share of their income towards purchasing such goods than the wealthy.
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