<p>VAT has deadweight losses caused by higher prices. Income tax has deadweight losses caused by lower take-home wages (which shifts the demand curve down). Both cause fewer transactions (which is where the deadweight loss happens) and therefore both reduce economic growth.</p>
<p>Income taxes reduce the incentive to work. While the job market is naturally quite inelastic, the existence of welfare makes it less so. So an increase in income taxes may increase unemployment to some degree.</p>
<p>On the other hand, VAT is a highly regressive tax, hitting the poor harder. That said, <a href="https://governology.substack.com/p/taxes" rel="nofollow noreferrer">income taxes aren't always as progressive as tax brackets might make it seem</a> - especially in the US where a labyrinth of loopholes actually make it regressive as well (tho probably not as much as VAT and sales tax are).</p>
<p>VAT would definitely raise prices, which would be seen as inflation. Markets nearer to perfect competition would see higher price rises than markets with more oligopolistic behavior. However, this would basically be a fixed one-time price increase, and the rate of increase thereafter would be unaffected (because long-run price inflation is only affected by monetary inflation).</p>
<p><a href="https://governology.substack.com/p/taxes" rel="nofollow noreferrer">I wrote more about taxes here</a>.</p>

CC BY-SA 4.0
2023-07-22T16:39:22.873Z
2023-07-22T16:39:22.873Z
Governology
<p>Was wondering how the effect of VAT (indirect taxes) differs from the effect of income tax (direct taxes), in terms of their impact on the 4 marco objectives (unemployment, inflation, balance of payments and economic growth)?</p>

<macroeconomics><taxation>
VAT vs. Income tax - How their effect varies
user35399
# VAT vs. Income tax - How their effect varies

(Asked by: username_0 on 2016-04-05)

Was wondering how the effect of VAT (indirect taxes) differs from the effect of income tax (direct taxes), in terms of their impact on the 4 marco objectives (unemployment, inflation, balance of payments and economic growth)?

**Tags:** macroeconomics, taxation

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## 1 answers

### Answer by username_1 on 2023-07-22. Score: 1

VAT has deadweight losses caused by higher prices. Income tax has deadweight losses caused by lower take-home wages (which shifts the demand curve down). Both cause fewer transactions (which is where the deadweight loss happens) and therefore both reduce economic growth.

Income taxes reduce the incentive to work. While the job market is naturally quite inelastic, the existence of welfare makes it less so. So an increase in income taxes may increase unemployment to some degree.

On the other hand, VAT is a highly regressive tax, hitting the poor harder. That said, [income taxes aren't always as progressive as tax brackets might make it seem](https://governology.substack.com/p/taxes) - especially in the US where a labyrinth of loopholes actually make it regressive as well (tho probably not as much as VAT and sales tax are).

VAT would definitely raise prices, which would be seen as inflation. Markets nearer to perfect competition would see higher price rises than markets with more oligopolistic behavior. However, this would basically be a fixed one-time price increase, and the rate of increase thereafter would be unaffected (because long-run price inflation is only affected by monetary inflation).

[I wrote more about taxes here](https://governology.substack.com/p/taxes).


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