Explain the relationship between taxation and inflation?

Question

Explain the relationship between taxation and inflation?

Answer 1

Strictly speaking, a tax is a redistributive tool by which government takes some amount of money from one group and gives it to another (or, to itself to use for public projects), In that sense, no "new" money is created. Remember, there is a correlation between the supply of money and inflation. Here, we do not strictly have any new supply.

However, we also have to look at the consequences of a redistribution of money. For this, you have to ask, Who gets the tax money, and what do they do with it?

The reverse of a tax increase would actually result in a return of money to taxpayers. So in this sense one may argue, we are "pumping" money back into the economy. However, the money was never "gone" to begin with, it simply shifted hands (from governments to the taxpayers).

However, the taxpayer who does receive tax money (i.e. a rebate) will usually spend some of it. By spending, he or she is consuming, and this is believed to help the economy.

In some instances there is the following link:

tax cut-->leads to-->more consumer spending-->leads to-->economic growth-->potentially leads to-->inflation

Political parties differ on this. Republicans generally believe tax cuts are good (as they return money- redistribute it that is) to small businesses and industry, while Democrats believe it is more "fair" to spread wealth around. But there is no definitive connection between taxation and inflation (for every argument stating that taxation leads to inflation you will find an argument to the opposite).

For example, above I showed how a tax reduction can increase inflation via consumer demand. But a tax increase may have the same effect if it increases operating costs. (via producer supply).

Answer 2

taxes increase prices, which increases production costs, which further increases prices, and so on.

and increasing prices mean inflation.