3. Progressive Taxes
Increasing progressive taxes such as the higher rate of income tax from 40% to 50% will take more income from those on high income levels. This enables cuts in regressive taxes and increased benefits which help increase the income of the poor. This can be an effective way for reducing relative poverty.
However, critics argue higher income taxes create a disincentive to work., leading to less output. This is because higher tax makes work less attractive and reduces the opportunity cost of leisure. Therefore people work less and enjoy more leisure. This is known as the substitution effect. Similarly higher corporation tax may discourage investment in the UK
However this is disputed by other economists. Higher tax reduce incomes and this may encourage people to work more, to maintain their income. (This is known as the income effect)
Evidence suggests that higher income tax has little incentive on the supply of labour, suggesting labour supply is relatively inelastic. However, it also depends at what level income tax is set. There is certainly a level where higher income tax will reduce incentives to work.
Other problems with increasing income tax, include tax evasion and the fact firms may adjust wages to compensate for the higher taxes.