A Taxing Business

Rachel Reeves is being criticised, predictably, by businesses for increasing employer NI; however, a key question is whether taxing consumers or businesses is the better approach for raising revenue without triggering a recession. Let’s explore the dynamics.

 

Taxing consumers reduces their disposable income, leading to an immediate drop in spending. Since consumer demand drives a significant portion of the economy, this reduction can ripple through businesses, resulting in lower revenues, job cuts, and investment slowdowns. This cycle risks pushing the economy into recession. Low-income earners, who spend most of their income on necessities that keep the economy going, are particularly affected. Taxing them not only increases inequality but also reduces the money circulating in the economy, as they typically spend a larger proportion of their earnings than wealthier groups.

Taxing businesses can reduce profits, potentially affecting investments and hiring. However, if consumer demand remains stable, businesses are less likely to make drastic cuts. They might absorb some of the tax through lower profits or pass costs onto consumers, depending on market conditions. High-margin sectors, such as technology or pharmaceuticals, can better withstand higher taxes, whereas low-margin industries like retail or hospitality might struggle. Nonetheless, taxing businesses is less likely to cause an immediate drop in economic activity compared to taxing consumers.

High-margin sectors, such as technology, pharmaceuticals, and luxury goods, operate with significant pricing power and lower sensitivity to increased taxes. Conversely, low-margin industries, like retail, hospitality, and agriculture, are vulnerable to cost pressures and intense competition, leaving little room to absorb additional taxes. 

On balance, taxing businesses is less likely to harm economic growth, as long as consumer demand remains intact. Businesses have more flexibility to adjust to higher taxes without cutting jobs or investment. Taxing consumers, particularly low-income earners, can be counterproductive, reducing demand and triggering a downward spiral of economic contraction. 

However, governments can balance the burden by targeting high-margin sectors, offering incentives for business reinvestment, and protecting lower-income groups from excessive taxation.

Effective taxation requires a nuanced approach. While taxing businesses tends to have a less immediate impact on the economy, sector-specific considerations are crucial to avoid unintended consequences. By prioritising policies that protect consumer demand and target those most capable of bearing the tax burden, governments can raise revenue without undermining economic stability.

Reeves is taking a calculated gamble with logic on her side, but it's still a gamble.