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61 views4 pages

ECO Assignment

Uploaded by

Abdul Aziz
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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University of the People

ECON 1580: Introduction to Economics


Learning Journal: Unit 8
The Impact of Changes in Business Taxes, Personal Income Taxes, and Transfer
Payments on GDP
Instructor: Ogochuku Fisher
Fiscal policy plays a crucial role in shaping a nation’s economic performance, particularly
through its influence on gross domestic product (GDP). Changes in business taxes, personal
income taxes, and transfer payments can significantly impact economic activity by altering
consumption, investment decisions, and overall demand within an economy. Understanding
these dynamics is vital for policymakers as they navigate the complexities of fiscal policy to
promote economic stability and growth.

Business Taxes and Their Effect on GDP

Business taxes directly influence corporate profitability, investment decisions, and overall
economic growth. When business taxes increase, firms face higher operational costs, which can
lead to reduced profitability. Consequently, businesses may cut back on investments in capital
goods, research and development, and expansion plans, leading to a decline in aggregate demand
(Rittenberg & Tregarthen, 2019). This reduction in investment can stifle innovation and
productivity gains, further hindering GDP growth. Conversely, when business taxes are lowered,
firms retain more of their earnings, which can incentivize them to invest more in their operations.
Increased investments lead to higher levels of employment, as businesses may need to hire
additional workers to meet the increased demand for their products or services (Mankiw, 2016).

Moreover, changes in business taxes can have ripple effects on the broader economy. For
instance, lower corporate taxes can encourage foreign investment, attracting multinational
corporations to establish operations in a country, thus contributing to GDP growth. Additionally,
a robust business environment can enhance consumer confidence, leading to increased spending.
Conversely, high business taxes can deter investment and lead to capital flight, where businesses
relocate to countries with more favorable tax conditions, negatively impacting the domestic
economy (Barro & Redlick, 2011).

Personal Income Taxes and Their Effect on GDP

Personal income taxes also play a significant role in determining the disposable income of
consumers. Higher personal income taxes reduce the amount of money individuals have to
spend, thereby diminishing their purchasing power. When consumers have less disposable
income, they tend to cut back on spending, which is a primary component of aggregate demand.
This reduction in consumption can lead to slower economic growth, as businesses experience a
decline in sales and may respond by cutting back on production and employment (Blanchard &
Johnson, 2012).

Conversely, reducing personal income taxes can stimulate economic activity by increasing
disposable income. This increased purchasing power encourages consumer spending, which in
turn drives business revenue and, ultimately, GDP growth. The marginal propensity to consume
(MPC) is a key concept here; it represents the proportion of additional income that consumers
are likely to spend rather than save. A higher MPC suggests that tax cuts will lead to significant
increases in consumption, thereby positively affecting GDP (Krugman & Wells, 2020).
Furthermore, lower personal income taxes can enhance consumer confidence, encouraging
individuals to spend rather than save, further stimulating economic growth.

Transfer Payments and Their Effect on GDP

Transfer payments, such as unemployment benefits, social security, and welfare, are critical tools
for stabilizing the economy and supporting those in need. These payments provide individuals
with the financial means to maintain their consumption levels, particularly during economic
downturns when personal income may decline (Mankiw, 2016). Transfer payments have a direct
positive impact on GDP by increasing overall consumption, especially among low-income
households, who tend to have a higher MPC. When these households receive transfer payments,
they are likely to spend a significant portion of that income on essential goods and services,
thereby driving demand and supporting economic growth.

Moreover, transfer payments can act as automatic stabilizers in the economy. During economic
recessions, increased unemployment benefits and other transfer payments help cushion the
impact of falling incomes on aggregate demand. This stabilization can prevent deeper recessions
and support a quicker recovery, thereby minimizing fluctuations in GDP (Barro & Redlick,
2011). Conversely, reductions in transfer payments during economic expansions can lead to
decreased consumption among vulnerable populations, potentially undermining economic
growth.

Changes in business taxes, personal income taxes, and transfer payments have profound effects
on a country’s GDP. Business taxes influence corporate investment decisions, while personal
income taxes affect consumer spending power. Transfer payments serve as a crucial mechanism
for stabilizing demand during economic fluctuations. Policymakers must carefully consider the
implications of fiscal policy changes on GDP, as these decisions can significantly shape the
economic landscape and influence long-term growth trajectories.

Word Count: 740

References

Barro, R. J., & Redlick, C. (2011). Macroeconomic Effects from Government Purchases and
Taxes. The Quarterly Journal of Economics, 126(1), 51-102. https://doi.org/10.1093/qje/qjq003

Blanchard, O., & Johnson, D. R. (2012). Macroeconomics (6th ed.). Pearson Education.
https://www.pearsonhighered.com/assets/preface/0/1/3/6/013671546X.pdf

Krugman, P., & Wells, R. (2020). Macroeconomics (6th ed.). Worth Publishers.
https://studyroombd.wordpress.com/wp-content/uploads/2014/08/macroeconomics-krugman-
wells.pdf

Mankiw, N. G. (2016). Principles of Economics (7th ed.). Cengage Learning.


http://repo.darmajaya.ac.id/5062/1/Principles%20Of%20Economics%20by%20N.%20Gregory
%20Mankiw%20%28z-lib.org%29.pdf

Rittenberg, L., & Tregarthen, T. (2019). Principles of Economics (3rd ed.). OpenStax.
https://openstax.org/details/books/principles-economics-3e

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