Thursday, May 10, 2007

How taxes weigh on economy

Once again as stock indices continue to rise, I want to return to one of my previous posts on the way taxation affects our economy. This time I’ll share some thoughts on the mechanism behind it.

Suppose you have a stock portfolio that you want to grow, naturally you’ll try to invest more into those companies that make more money and less into those that make less otherwise the whole portfolio will grow more slowly and perhaps even decline in value.

Now imagine that the portfolio is US economy and the companies are its citizens. Our tax system is based on taking more money from those citizens who make more and investing into those who make less, which is complete opposite to promoting growth. In fact the taxation system we have provides a constant growth inhibiting effect on the economy. This effect is stronger than Federal Reserve Bank’s policy or any other financial instrument the government has. Therefore each time taxes increase economy declines and vice versa, although the effect is usually seen after a few years.

Obviously there are social reasons for the current tax system that should not be overlooked, but at the same time when economy goes down everybody suffers, especially those who make less. So the point is to always keep the taxes at the minimum required to provide for the social need as this will ensure continuous growth and more wealth for everyone.