Lower income tax rates increase the spending power of consumers and can increase aggregate demand, leading to higher economic growth (and possibly inflation). On the supply side, income tax cuts may also increase incentives to work – leading to higher productivity.

How will a decrease in personal income taxes and an increase in government spending affect consumer spending and unemployment in the short-run? Prices are rigid downward and decreases in aggregate demand will lead to an increase in unemployment.

A higher tax rate increases the burden on taxpayers. In the short term, it may increase revenues by a small amount but carries a larger effect in the long term. It reduces the disposable income of taxpayers, which in turn, reduces their consumption expenditure.

But this is a big myth. India has very few taxpayers not because millions of them are hiding their incomes and evading taxes. It is because India’s income tax structure is designed in a way that allows only for a small percentage of people to pay income tax. Let us first understand who should pay income tax in India.

To dampen economic growth and inflationary pressure, the government can increase taxes and keep spending constant, or decrease spending and keep taxes constant. To stimulate growth and reduce unemployment, the government can decrease taxes and keep spending constant, or increase spending and keep taxes constant.

Gross domestic product, or GDP, is a common measure of a nation’s economic output and growth. GDP takes into account consumption, investment, and net exports. While GDP also considers government spending, it does not include transfers such as Social Security payments.

Government spending represents government consumption expenditure and gross investment. Governments spend money on equipment, infrastructure, and payroll. Government spending may become more important relative to other components of a country’s GDP when consumer spending and business investment both decline sharply.