How do high taxes effect an economy?

We would think that the higher the taxes the government levies on corporations and individuals, the richer the government gets. You would be surprised to know that the government gets poorer. Let us see how?

Take the example of India. India is a developing economy and a net importer i.e it imports more and exports less. Therefore, the treasury runs into a deficit. An efficient government has the capability to run the economy with minimum taxes. But the Indian government's pyramid structure makes it difficult for it to run the economy in the same way as a business man would run his enterprise. Moreover due to the absence of transparency and a proper revenue collecting system, a lot of people end up not paying taxes. Therefore, the government ends up taxing the corporations and individuals more.

Let us see with the help of a simple diagram, the effect high taxes have on an economy.

In a high tax environment, more jobs are lost as the equilibrium shifts. Companies recruit less, since they save less and expand less(due to large tax losses). This leads to reduced tax revenue for the country, which causes deficits i.e expenditure exceeds revenue. The country relies more on external debt i.e it borrows from countries like America. The country ends up paying more interest on the debt. This interest has to be paid in dollars. Therefore, the Indian currency gets devalued, because the demand for dollar against the rupee increases. This causes inflation since India is a net importer.

 The bottom line is in order to become rich, Indian government should focus more on productivity and rely less on taxes. Productivity can be enhanced by making the environment pro growth by providing faster clearances and implementing projects on a fast track. This will cause people from the developed countries to invest more in India. Why? Because they get a hassle free environment and the returns on their investments will be much higher here in India(since India is growing faster when compared to developed economies, which have reached a level of saturation).

I will be discussing more on the effect of taxes on drugs, wages and productivity in the coming weeks. So stay tuned!!!

Disclosure: The image has been downloaded from the Internet.