With interest rate rises, the people in the most debt suffer the most. With tax rises, the highest paid suffer the most, and the govt has extra revenue to help the ones struggling the most. This is never considered by any govt. Why not?
In: 1129
Taxes tend to be used to discourage certain kinds of commerce (e.g., cigarettes or alcohol) and in some places are local rather than national. Banks touch many kinds of commerce. Interest rates are also more easily adjustable (though some tax hikes and cuts are also temporary). The stated intent of taxes tends to be to fund the government.
In most Western countries interest rates are controlled by a central bank. They can unilaterally take action to address monetary issues. Raising taxes is much more complicated and involves passing a bill through the legislature which takes a lot of time and political capital.
Can you imagine what the inflation situation would like if Congress was responsible for it? They would still be arguing over whether we should raise taxes or slash government spending for the poor.
Edit: reading to raising taxes.
Edit 2: As several people have pointed out Central banks handle monetary policy, not fiscal. I used the wrong word in my original answer. Thank you for the corrections. Mea culpa.
It’s a lot easier procedurally for the fed to raise the federal funds rate than it is for congress to vote in a tax increase. Tax increases also don’t slow the economy the way a funds rate does. The funds rate basically serves to determine how expensive it is for businesses to obtain money to invest and grow. Lowering it makes it more advantageous for businesses to expand, and raising it leads to businesses being more cautious about new ventures, as it takes a greater return to pay off the loan. In both cases, the amounts of money involved dwarf the amounts of money a tax increase would bring in, which means they have a much greater impact on the overall economy.
Because the interest rates are less abount people’s credit card debt, and more about banks lending to eachother and to businesses. Raising interest rates slows liquidity in the system, which slows loan growth and economic activity. Loan growth is the main way we have growth and inflation.
Cheers for all the answers. I’m a Brit, our central bank is ‘independent’. The govt decides what they do and who the Governor is though.
(Mostly) Good answers so far. Another problem is that everyone complains the government runs large deficits. Say they DID raise taxes. Now the government has money. Well here in the US the left would demand they spend that money on public services, the right would demand you cut taxes and give it back to taxpayers, both of put money back into circulation which is exactly what you’re trying NOT TO DO.
People don’t like taxes and tend not to vote for politicians who raise them. People do not vote directly for the people who raise interest rates.
Raising interest does slow the economy, but that is just the end result of what’s actually happenning. What’s happenning is that money creation is slowing down. When the Fed raises interest rates, the desire for banks and lending institutions to borrow money from the fed goes down.
If the cost to borrow x amount of money is 2.5% and that is twice as high as it was last year, then it becomes more difficult to sell loans to businesses and consumers. Banks have to make money off the loan, when the base interest rate for then has increased, They need to increase the interest consumers will pay to maintain their expected profits. And because less loans are expected to be made because consumers and businesses can’t afford to take out as many loans, banks must raise the rates even further to make up for lost loans.
This is why interest changes are made in small increments by the fed, to see how the market reacts and slow the economy down at a controlled rate. You wouldn’t want to crank the interest up an alarming ammount all at once, everyone would freak out. If one month you could buy a car for $450/month, and the next month that same car cost $650/month, less people would buy that car. But if you slowly raise the rates, month over month, with the price of that car raising about $50/month in payment, and then keeping an eye on the purchase behavior of consumers, the fed can determine how much demand is cooling down.
The idea is that when demand lowers, businesses will have to lower the prices of things to generate demand in order to sell. The lowering of prices, is exactly what the increase to interest rates aims for. This is known as deflating the economy. Interest rates have a primary cause/ effect on inflation/ deflation. We want a slight monetary inflation at all times, ideally a little less than the fed monetary rate. Usually, year over year about 2%
When there’s worries about a recession, or slow down in the economy, the fed lowers interest rates to make it more enticing for consumers and businesses to borrow money. When money is borrowed, things are bought and sold. More money goes into the economy, work is paid for, jobs are created, the value of things slowly rise because more people can afford it. This is inflation, but controlled.
Now, to your question. Why doesn’t the government just use the power of taxation to slow the economy, well, interest rates controlled the rate of money creation, taxation rate is the rate of monetary destruction. While the government is the largest employer in the US, the government doesn’t create goods or services that exchange an equal value for the taxes.
We get services like infrastructure, police, military, and the rest goes to running it all. The part responsible for running it all is called bureaucracy, which ammounts to the vast majority of government. Business has bureaucracy, granted, but compared to the goods and services created, a business’s bureaucracy is only about 10% of the business, within government, its easily 70-80% if not more. This means that 70-80% of tax money doesn’t return in the form of a tangible goods or services, just money that goes to feed the machine if you will.
Without an effective impact on controlling demand, taxation in the place of interest rate control doesn’t have the same effect as interest adjustments.
Already covered: Central banks (the US Federal Reserve or in your case the Bank of England) are independent organizations that have the duty to control interest rates and inflation, but have no control over taxes, which are in the remit of Congress / Parliament.
New bit: More importantly, inflation is a case of *too much money* in circulation relative to the goods and services available. Central banks can solve this by raising their rates, which makes it more expensive to bring new money into circulation.
But raising taxes, doesn’t solve inflation: if you tax the rich and spend it on the poor, it doesn’t change the overall money supply. You’ve just redistributed it. Now, if Congress/Parliament raised taxes and *didn’t* spend the money, just set it all on fire or something, that *would* reduce inflation, but it would not be very popular!
Taxes are politically unpopular and Congressmen are constantly worrying about reelection. The people who control the Fed and set interest rates are appointed to those positions and don’t have to worry what the voting public thinks of them.
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