The term income tax is the percentage of income that is taken from a person’s income to fund government expenses. Income tax itself is a direct tax as it directly taken from a person’s earning’s and can be used by the government to cut or increase disposable income to increase or slow down consumer spending. Income tax is also used as a fiscal policy to attempt to eliminate the countries budget deficit. The government have four main economic objectives these include Balance of payments, lower unemployment, steady inflation and steady economic growth.
In the short run a cut in income tax leads to an increase in disposable income for consumers. If consumers have more disposable income they are like to spend more, therefore increasing consumer spending. The increase in consumer spending means there is more aggregate demand in the UK. If there is more aggregate demand in the economy this will lead to businesses increasing their work force decreasing the countries rate of unemployment and therefore increasing the Gross Domestic Product within the UK. However if there is too much aggregate demand within the economy this will lead to demand pull inflation. Demand pull inflation isn’t such a bad thing for the government as long as it happens at a steady rate which is an economic objective, however if aggregate demand continues to increase this could lead to high rates of demand pull inflation which means that the pound is losing its value at a faster rate year on year which is a huge increase in British prices. If there is an increase in prices the standard of living will go down and could lead to higher crime and more poverty for lower income families. This short term decrease in taxation can also lead to an increase in the countries budget deficit because they are taxing less. The increase in disposable income may be saved by consumers so it won’t contribute to aggregate demand.
In the long run a cut in income tax could lead to more investment spending. This is because consumers with a higher income may seek to invest their disposable income into big businesses instead of saving their money. Big businesses then use this invested money to buy capital goods. These capital goods then need workers to use them so it decreases unemployment. With a rise in aggregate demand this will decrease the amount of cyclical unemployment as there will be more demand for workers in a busier economy. Also if there is more investment spending in the UK, then it will mean that businesses will grow and the UK will have bigger firms in the country. This means that there will be more demand abroad for these big businesses to supply for. This leads to an national increase in exports. If there is more