Fact Checked

What Are Induced Taxes?

K.C. Bruning
K.C. Bruning

Induced taxes are changes in taxation that move with the gross domestic product (GDP). For example, when the GDP is high, taxes tend to be high, and vice versa when it is low. The concept of induced taxes is that they are meant to stabilize the economy by keeping the flow of money level with the overall economy. These taxes can be short or long-term, depending on the economic situation.

One of the most important purposes of induced taxes is to stimulate the economy. When there is a drop in the market, taxes are lowered in order to encourage spending, which will subsequently boost the economy. In a strong economy, induced taxes are meant to collect revenue for the government when it is readily available. When the economy dips, it will have reserves. This enables the government to lower taxes in order to encourage spending which results in economic stimulus.

Man climbing a rope
Man climbing a rope

Induced taxes can be introduced on a national or regional level, depending on the needs of the government. In addition to the GDP, they can be applied in relation to income and corporate earnings. If a person’s income drops, then lower taxes will be assessed to the individual in order to ensure that he or she has the funds to continue to contribute to the economy.

The primary reason for applying induced taxes to corporations is that they encourage companies to maintain certain employment levels. This is because rather than being calculated based on turnover, the taxes are based on profits. By determining taxes based on profit, the company is able to benefit from lower taxes before it must resort to a reduction in workforce. This helps to avoid the threat of or exacerbating a recession as profits tend to fall faster than employment levels.

When there is an economic downturn, one of the benefits of induced taxes is that lower rates usually lead to domestic spending. This is because there is usually a lower volume of imports during a recession. The result is that any extra cash given to taxpayers tends to stay in the country, thus boosting the economy more quickly.

Induced taxes are a tool known in macroeconomics as an automatic stabilizer. Other stabilizers include welfare and unemployment benefits. The common thread among these elements is that they are driven by the economy, rather than policy changes. Despite this, in some cases these kinds of taxes may be accompanied by changes in policy.

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Discussion Comments


@Markerrag -- that may be the case in some instances, but there are cases where individual states can prepare for such drops in revenue. Some of those states, for example, come with "A," "B" and "C" items in their budgets. The "A" expenses must be funded, the "B" ones will be funded if there is enough money to do so while the "C" items will get what is left over.

In other words, most things will be funded when times are good and taxes are high. When the economy dips and revenue goes down, then the items in the "B" and "C" categories might be at risk. In that type of budgeting, the government will not shut down if it doesn't have any revenues -- the more important government functions will be funded, while others might not be.


How likely are induced taxes to actually work? While they might stimulate the economy when times are bad by freeing up more capital for citizens and corporations to spend, the problem is that governments tend to spend every dime they take in and, in many cases, actually go into debt.

When times are good and reserves are supposed to be set aside for times when the economy is down, the likely scenario seems to be that the government will do exactly what individual do -- spend to its income and borrow more if necessary. If no reserves are kept, then the government will run short on revenue when taxes are lowered.

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