Discuss whether raising government revenue through taxation or enhancing productivity is the better approach to promoting inclusive growth while ensuring long-term fiscal health.
Fiscal policy plays a vital role in supporting inclusive growth. However, as budget surpluses diminish, enhancing tax revenue and boosting productivity will become essential to maintaining fiscal sustainability and advancing inclusive growth.
b. Discuss whether raising government revenue through taxation or enhancing productivity is the better approach to promoting inclusive growth while ensuring long-term fiscal health. [15]
Introduction
Inclusive growth refers to economic expansion that benefits all segments of society, particularly lower-income groups, while fiscal sustainability ensures that government policies are financially viable in the long run. In addressing these objectives, governments can either increase tax revenue—particularly from higher-income individuals—to redistribute wealth and fund social programs, or raise productivity to drive long-term economic growth and improve wages. While raising tax revenue can directly reduce income inequality and strengthen public finances, it may discourage investment and reduce economic efficiency. Conversely, raising productivity can lead to sustainable and broad-based economic expansion, increasing overall incomes and government revenues without imposing additional tax burdens. Both approaches have strengths and limitations, making a balanced strategy necessary to achieve inclusive growth while maintaining fiscal sustainability.
How Raising Tax Revenue Can Achieve Inclusiveness and Fiscal Sustainability but May Worsen Growth
One method of increasing tax revenue is through higher taxation on high-income individuals, which can directly reduce income inequality.
By increasing income tax rates for higher earners, the post-tax income disparity narrows, leading to a lower Gini coefficient, which is a key indicator of income inequality.
The additional revenue collected from wealthier individuals can be used to fund social programs, education, and healthcare subsidies, improving access to essential services for lower-income groups and making economic growth more inclusive.
From a fiscal sustainability perspective, higher tax revenues improve the government’s budget position, reducing deficits and ensuring long-term financial stability.
However, raising tax revenue also has potential drawbacks:
Higher taxation on high-income individuals and businesses may discourage investment, entrepreneurship, and capital formation, slowing economic growth.
If high earners face significantly increased tax burdens, they may relocate or shift their wealth elsewhere, leading to capital flight and reduced overall tax revenues in the long term.
Higher corporate taxes could reduce firms' incentives to expand operations, leading to lower job creation and slower wage growth, ultimately undermining the goal of inclusive growth.
While increasing taxes can enhance fiscal sustainability and improve income distribution, excessive reliance on this approach risks stifling economic expansion and reducing incentives for wealth creation.
How Raising Productivity Can Achieve Inclusive Growth While Maintaining Fiscal Sustainability
Raising productivity is a long-term strategy that focuses on enhancing economic efficiency, increasing output, and improving workforce skills, leading to sustained and broad-based growth.
Investment in supply-side policies, such as technology adoption, automation, and workforce upskilling, increases the economy’s productive capacity. This shifts the long-run aggregate supply (LRAS) curve rightward from AS₀ to AS₁, leading to higher potential growth.
Higher productivity results in increased wages and employment opportunities, particularly if efforts are made to reskill low-income workers. This helps reduce income inequality by enabling lower-skilled workers to earn higher wages, thus making growth more inclusive.
Sustained economic expansion leads to higher corporate profitability and wage growth, which naturally increases tax revenue without the need for tax hikes. As a result, the government can improve fiscal sustainability without discouraging private sector investment.
However, raising productivity also presents challenges:
Supply-side policies take time to yield results, making them less effective for immediate fiscal challenges.
If productivity growth primarily benefits high-skilled workers, income inequality could worsen if low-skilled workers are left behind.
There is no immediate guarantee that productivity gains will translate into equitable wage increases, requiring government intervention to ensure inclusive distribution of economic benefits.
While raising productivity fosters long-term fiscal sustainability and inclusive growth, the time lag and risk of uneven benefits necessitate complementary policies to ensure broad-based economic improvements.
Evaluative Conclusion: A Balanced Approach is Necessary
Both raising tax revenue and raising productivity offer unique advantages and challenges in achieving inclusive growth while maintaining fiscal sustainability.
Increasing tax revenue—particularly from higher-income individuals—immediately reduces income inequality and strengthens government finances. However, it may discourage investment and economic expansion, limiting future growth potential.
Raising productivity fosters sustainable economic growth and organically increases government revenue, reducing the need for tax hikes. However, it takes time to implement and requires targeted policies to ensure inclusivity, particularly for low-skilled workers.
Given these trade-offs, a balanced approach is the most appropriate strategy.
Progressive taxation policies should be implemented carefully, ensuring that tax increases do not significantly discourage investment or economic activity.
Supply-side policies should be targeted toward upskilling lower-income workers, ensuring that productivity gains translate into wage growth across all income levels.
By combining moderate tax adjustments with investments in productivity-driven growth, governments can achieve a more inclusive and fiscally sustainable economic environment, benefiting both present and future generations.
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