How Governments Can Harm Economic Growth

In the previous tutorial we talked about how governments attempt to grow economies by doing

things to increase productivity, often with great success. However, sometimes things don’t work out

as intended, as governments can do things that actually harm economic growth. Let’s look at five

specific ways governments can mess up economies. #1: Overtaxation.

Taxation is a powerful tool that the government uses to pay for public goods and services.

Taxes give the government the money it needs to operate. However, it is important to think about

who actually bears the burden of a tax. Taxes can create disincentives and other behavior that

discourages investment. So while governments absolutely need taxes to pay for obligations,

since it’s the primary way they collect money, they also need to be careful not to tax too much.

Let’s look at two distinct ways taxes can end up harming economic growth.

The first is increasing prices for ordinary consumers. For example, suppose the government

collects a gasoline tax of 50 cents per gallon from gas stations. At first, you might assume

that the tax burden is only on the gas stations. However, in response to the tax, gas stations may

increase the price of gas. Therefore, consumers will also carry the burden of the tax.

When policymakers consider creating a new tax, they must consider the incidence of a tax, or the

final burden of a tax. This is because producers often pass on the burden of a tax to consumers.

The second is discouraging domestic investment. Simply put, if taxes make the

cost of doing business too high in one country, companies will take their business elsewhere.

For example, suppose the government increases the corporate income tax rate, which is a tax

on business profits. In response, a company might move its headquarters to another country to avoid

paying the higher corporate tax rate. In fact, the company will likely move to a country with

no corporate tax. Back in 2017, Google shifted 23 billion dollars to Bermuda. At the time,

the United States had a 21% corporate income tax rate, while Bermuda had no corporate income tax.

So whenever a policymaker proposes either a new tax or a higher tax rate,

they must consider the degree to which that change might scare off producers or consumers.

#2: Too much or too little regulation. Whenever governments regulate an economy,

they are manipulating a free market. This can have both positive and negative effects on an economy.

It’s probably easier to understand the negative effects of regulation.

First, highly regulated industries can make it difficult for competitive markets to form.

If a company has to spend lots of money keeping up with regulations, it may hurt their profits. More

importantly, a large company or corporation may be able to handle spending extra money

to keep up with regulations, but a brand new company starting out won’t be able to.

This results in fewer companies in a market, which often results in higher prices for consumers.

More government regulation also means more bureaucracy, and therefore more

government spending. This can lead to government inefficiency, corruption, and increased taxes.

Too little regulation can also hurt economic growth. To understand why that is,

let’s look at why regulations can be a good thing. First, regulations can raise industry standards,

resulting in higher quality goods and services. For example, because governments often put in

place strict requirements for food processing and preparation, consumers are more confident