Effects of Increase in Tax on Consumer Spending

Effects of Increase in Tax on Consumer Spending

There are several effects of increase in tax on consumer spending. Tax can be defined as an involuntary fee that is levied on corporations or individuals and a government entity enforces it whether national, regional or local and it is used to finance the activities of the government. Taxes are usually levied by a state on its citizens as well as corporations for purposes of funding public services and works. Usually, paying taxes at the rates that the state sets is compulsory. Deliberate tax evasion is a punishable offense. Different departments or agencies are used to collect taxes for the government. Consumer spending is the money that households spend in an economy. This includes spending on nondurables and durables. Increasing taxes on income, capital gains, interest and dividends affects consumer spending in various ways.

How effects of increase in tax on consumer spending come into play

  • Tax increase reduces the available disposable income

Consumer spending forms the largest portion of GDP. When consumers pay increased taxes, they take a little amount of money home as disposable income. This implies that consumers will have little or no money to spend on their essentials. As such, demand for more services and products will be low because consumers have little money to spend. Thus, consumer spending will be decreased by increase in taxes.

  • Increase in tax increases goods’ prices and this reduces consumer spending

When the government increases tax on services and goods such as value added tax the prices of such services and goods increase. This leads to a reduction in the demand for such services and products because consumers will choose substitute services and products that have not been affected by the tax increase. If the tax increase affects several services and goods, the overall consumer spending reduces significantly.

  • Tax increase leads to demand reduction

When the government increases tax on specific commodities, consumers will go for substitutes that are relatively affordable. For instance, if the government imposes more taxes on luxury products, some people might opt to live without them. This implies that an increase in tax reduces demand thereby reducing consumer spending.

  • Increased taxation leads to poor living standards

An increase in tax reduces consumer spending and this means poor living standards because most people are forced to survive without some commodities. Due to increased price of commodities, consumers spend what they have as their disposable income. This leaves them without money to spend on quality services and products.

  • Increase in tax leads to economic deterioration

Excessive increase in taxes impact on the economy negatively. This is because it discourages consumer spending. This decreases business revenue. Basically, the overall amount of the tax that the government collects is lowered due to a reduction in economic activities that businesses engage in as a result of excessive taxation. When taxes are high, businesses are unable to acquire the materials or commodities that they need to operate and they might even be forced to close down.

When and why effects of increase in tax on consumer spending become apparent

The government increases tax when it wants to generate more revenues and enhance economic growth and this is when effects that increase in tax has on consumer spending become apparent. Income tax and taxes that are levied on capital gains, dividends and interests are some of the major sources of revenue for the government. Although tax increase enables the government to generate more revenues and engage in important development projects, most effects of increase in tax on consumer spending are negative.

Therefore, policy makers should be careful when considering a tax increment because it has numerous effects. Some effects of an increase in tax can be long term especially if the increase in taxation is entrenched in the constitution of a country. This can cause a significant change in consumer spending behavior especially if consumers feel that the tax rates’ changes are permanent.

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