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The following points highlight the four major economic effects of taxation. The effects are: 1. A redistribution of income 2. A raising of prices 3. A reduction of incentive 4. A reduction of enterprise.

Effect # 1. A Redistribution of Income:
This effect is felt most in developing countries. A proportional tax will not affect the distribution of income, but both progressive and regressive taxes will cause a change in income distri­bution. With progressive taxes, the post-tax distribution of income is more equal than the pre-tax distribution, whereas with regressive taxes the post- tax distribution is more unequal than the pre-tax distribution.

Effect # 2. A Raising of Prices:
The imposition of or increasing the rates of indirect taxes will cause the prices of the taxed goods to rise. Increases in indirect taxes, therefore, have implications for a government’s policy in relation to inflation. Such increases can have adverse effects on the rate of inflation not only directly, via increased prices, but also indirectly, via increased wage demands made by workers due to rise in their cost of living.

Effect # 3. A Reduction of Incentive:
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It may be argued that increased taxation can have a disincentive effect on workers. They may feel that it is not worth taking on extra responsibility or putting in more hours because so much of their extra income would be taken in taxation.

However, it may be argued that workers may want to maintain their present standard of living or may have heavy financial commitments so that if income tax was increased, they would work for longer hours to make up for the income lost in tax.

There are, therefore, conflicting views on the effect of incentives. It would seem logical that there must be a discentive effect at some point but it is not clear at what level of taxation that point is reached.

Effect # 4. A Reduction of Enterprise:
Entrepreneurs undertake investment in anticipation of increasing profit. Investment projects may be risky so the expectation of large profits is an important incentive. If, however, profits are heavily taxed, the entrepreneurs may feel that it is not worth taking such risks and so they will be far more cautious in their attitudes. Such caution may lead to reduced progress and efficiency with a consequent deteriora­tion in the ability of domestic producers to complete with foreign rivals.