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In the short term, however, it appears that an increase in employers’ costs does not immediately lead to lower negotiated wages, especially in a tight labor market with low unemployment. As a result, labor costs will increase with an increase in employers’ costs, which reduces the demand for labor. Whether a change in employers’ costs is passed on to negotiated wages in the long term seems to depend on the institutional design of the labor market in a country. At least in the short term, for a government there is a trade-off between higher labor participation or lower labor costs if it chooses to lower the employee or employer wedge. You can visit taxfyle.com/tax-bracket-calculator and get all the information.

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In addition to the lowering of the tax rates, the government has various deductions and tax credits available to reduce the tax rates for specific groups. A tax credit that has a strong positive effect on labor participation is the employed person’s tax credit. Because this tax credit is only available to people with a job, it creates a greater difference in net income between working and non-working people. This provides a greater incentive to participate in the labor process.

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Related to this are the allowances for certain groups, often the lower incomes: because the level of allowances often decreases with a higher income, the marginal pressure (the extra net tax you have to pay when income rises) can in some cases be very high. It is failure, which makes it hardly worthwhile to work more. In some cases, this can even ensure that the decision to go to work leads to a reduction in net income, the so-called poverty trap. This often occurs when a person decides to start working on benefits and his total net income decreases due to the decrease in the allowances and schemes to which he was still entitled at a lower income.

From an economic point of view, it is therefore sensible to limit the number of allowances as much as possible and to introduce a specific employed person’s tax credit. However, this will have consequences for the purchasing power of groups: a higher employed person’s tax credit increases the income inequality between the active and the inactive, while lower benefits can strongly influence the purchasing power of specific groups.

Economic consequences of progressive tax system twofold

Most developed countries prefer a progressive tax system. In economics, a progressive tax system has traditionally been seen as bad for economic growth. A higher tax progression can lead to a decrease in the number of hours worked and make people decide to attend less education, as earning more becomes less rewarding. Also, higher tax progressivity can prevent entrepreneurship and risk-taking because higher taxes reduce the reward for risk-taking. 

Tax progression

However, recent research suggests that a progressive tax system actually contributes to economic growth. It turns out that countries with a progressive tax system and low income inequality are more stable economically and socially, which is good for economic growth. High income inequality can also lead to lower economic growth because investment in education in the lower classes is then lower. So while the question of whether higher income progressiveness leads to more economic growth is not an easy one to answer, recent research seems to indicate that a progressive tax system can have positive effects on the economy.

 

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