Effects of the Proposed Taxation on demand and supply

The effect of the proposed increase in taxation for the rich could be viewed in respect to the current economic environment. Increased taxation, according to the model, would result into a contractionary effect on the economy. The increase in taxes would decrease the amount of money available to the rich to commit into various expenses. Such an increase would reduce aspects such as investment, thus lowering real incomes and subsequently reducing the aggregate demand; the AD curve shifts to the left (figure, part B). The application of such a policy is ill informed in a time when the economy is recovering from a recession that arose from the 2007-2009 global financial crisis.

In addressing its two stated objectives (reducing inequality and reducing the budget deficit), the effect would be moderated by other factors. In reducing budget deficit, increased taxation would help if the government maintained its expenditures at a constant level. However, even then, the revenues gained from the increased taxation may not lead to elimination of the debt within the next five years due to the high value of the current deficit (Easterbrook, 2011; GPO, 2011). The approach to increase tax would be effective only when the government retains its expenditures at a constant level or reduces such expenditure (Mankiw, 2002). The approach would thus be effective in the current scenario where the Federal government has shown interest in cutting some of its expenses, for instance in areas such as defense (Hodge & Barnes, 2011).

An additional positive effect in addressing the budget deficit would be to reduce wastage resulting from tax breaks that do not meet their intended purposes. For instance, the reduction of tax revenues by mortgage interest has been argued to be counterproductive since it does not facilitate home ownership within the group the government targets with such breaks (Porter, 2012). Similarly, preferential treatment on taxing capital gains compared to income tax could also be counterproductive where the earners of capital gains fail to invest the proceeds to boost the economy (Porter, 2012). Accordingly, a policy that combines higher taxation for the rich with a reduction of tax breaks would help to reduce the budget deficit significantly.

With regard to income inequality, higher taxation for the rich may be counterproductive where it leads to reduced investment. In this respect, reduced investment would lead to higher unemployment levels thus widening the income gap. However, a higher tax for the rich could reduce income inequality when accompanied with government expenditure to spur employment activities in the country. For instance, using such revenues to enhance subsidies to farmers and local manufacturers could help them enhance their output, thus offer more employment. The government could ensure that its initiatives achieve desired results by linking the tax relief to the level of employment and wages. In this case, an employer who engages more individuals above a minimum wage level would get more relief.

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