In order to achieve six economic objectives, the government will affect the economic activities of the country. It will be done by arranging changes in TAXes, appropriate government spending (fiscal policies) and adjusting interest rates (monetary policy).
Let’s see now how specific changes in TAXation impact businesses and its major stakeholders – shareholders and customers.
Direct TAXes
Direct TAXes are paid to the government directly by employees and businesses. Direct TAXes include Individual Income TAX paid by employees, and Corporate TAX paid by businesses from Net Profits Before TAX.
1. Individual Income TAX.
a.) Increase (↑): Consumers will have less disposable income, so they will spend less money on purchasing goods and services. As there will be less demand for products, it will lead to fewer sales for businesses. In this case, employees may not be motivated to work as hard, therefore higher TAXes will negatively affect productivity. Businesses may offer more fringe benefits to compensate workers to improve motivation. Businesses will most likely focus on cost reductions, so that they can offer competitive pricing to attract customers. Some firms may reduce production levels to adjust to lower demand.
b.) Decrease (↓): Consumers will have more disposable income, so they will spend more money on purchasing goods and services. As there will be more demand for products, it will lead to more sales for businesses. In this case, employees may be more motivated to work hard, therefore lower TAXes will positively affect productivity. Businesses will not have to offer more fringe benefits to compensate workers to improve motivation. Businesses will most likely not need to focus on cost reductions, and there will be no need to offer competitive pricing to attract customers. Some firms may increase production levels to fulfill higher demand.
2. Corporate TAX.
a.) Increase (↑): Shareholders will receive less dividends. A smaller Net Profit After Interest and TAX means that smaller amount of money is available to be reinvested back into the business for growth. This will discourage existing and new investors from investing. Businesses may rethink their growth strategy and even relocate their operations to a foreign country with lower Corporate TAX rates. A smaller profit After Interest and TAX may also lead to businesses increasing prices to meet profit margins. Businesses will most likely have to look at other ways of obtaining funds.
b.) Decrease (↓): Shareholders will receive more dividends. A larger Net Profit After Interest and TAX means that larger amount of money is available to reinvest back into the business for growth. This will encourage existing and new investors to invest. Businesses may rethink their growth strategy and even relocate their operations back from a foreign country with higher Corporate TAX rates. A larger profit After Interest and TAX may also lead to businesses decreasing prices to become more competitive. Business will most likely not have to look at other ways of obtaining funds.
Indirect TAXes
Indirect TAXes are added to final prices of products, and are paid by customers when they make the purchase. Indirect TAXes include Consumption TAX (VAT, GST, IPI, or Sales TAX), as well as Import Tariffs and Quotas.
3. Consumption TAX.
a.) Increase (↑): Goods and services will become more expensive for consumers. So, the demand for related products will fall. Businesses now make fewer sales, so, they will produce less due to decreased demand. Businesses will have to become more price competitive.
b.) Decrease (↓): Goods and services will become less expensive for consumers. So, the demand for related products will grow. Businesses now make more sales, so they will produce more due to increased demand. Businesses will not have to become more price competitive.
4. Import Tariffs and Quotas.
a.) Increase (↑): Imported goods or goods using imported raw materials will become more expensive for consumers. So, businesses selling imported goods will see lower sales. It is because increased cost of imported raw materials will lead to higher cost of production. Local firms may benefit as demand for their products will increase. Some businesses may decide to use local raw materials which may be cheaper, but quality may suffer as a result. Local firms may set up more branches and expand.
b.) Decrease (↓): Imported goods or goods using imported raw materials will become less expensive for consumers. So, businesses selling imported goods will see higher sales. It is because decreased cost of imported raw materials will lead to lower cost of production. Local firms may not benefit as demand for their products will decrease. Some businesses may decide not to use local raw materials which may be more expensive. Local firms may not set up more branches and not expand.
All in all, governments receive their revenues mainly from TAXes. Therefore, steady growth in the economic activity of the country and full employment is what most governments aim for. So, Individual Income TAXes and Corporate TAXes will flow into the government’s budget.
Then, those TAXes will be used by governments to pay for investments which will be made in public services such as education, healthcare, transportation and so on. The more TAXes flow into the country’s budget, the more good things for the country the government can do.
