WHAT ARE 'Induced Taxes'

Induced taxes are a specific kind of tax. In the context of macroeconomics and fiscal policy, the term induced tax refers to a type of tax that changes when an economy's real gross domestic product or GDP changes.

BREAKING DOWN 'Induced Taxes'

Induced taxes are also a tool used by the government as an an automatic economic stabilizer. For example, when the level of real GDP falls substantially, which is indicative of an economic recession, the government can reduce taxes to help spur economic growth.The relationship between induced taxes and GDP is positive, meaning as real GDP rises, taxes will also rise, and vice versa. Known as the constant price, or inflation-corrected gross domestic product, the real gross domestic product is an inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year. The real GDP can account for changes in price level and provide a more accurate figure of economic growth. Because of the positive relationship between induced taxes and the real GDP, governments sometimes raise taxes in a healthy economy in order to capture the additional revenue. The converse also applies, with governments sometimes lowering taxes in a slow economy to help stimulate consumption.

Induced Taxes and Their Relationship to Real Gross Domestic Products

Induced Taxes and the real GDP have a positively correlated relationship. What does that mean? It means that two move in tandem: when one goes up the other goes up and vice versa.  Do not be misled by the name, however. A positive correlation does not guarantee growth or benefit. Instead, it is used to denote any two or more variables that move in the same direction together, so when one increases, so does the other.  A positive correlation exists when one variable decreases as the other variable decreases, or one variable increases while the other increases. A perfect positive correlation means that 100% of the time, the relationship that appears to exist between two variables is positive.

Induced Taxes as an Automatic Stabilizer

Automatic stabilizers get their name because they can stabilize economic cycles and automatically, without explicit government action. Induced taxes are used by governments so they will not have to take direct action, but these taxes will work to create economic change. By reducing taxes in the short term, an economy's consumption expenditure will increase, causing a rise in the short-term GDP. Automatic stabilizers are economic policies and programs designed to offset fluctuations in a nation's economic activity without intervention by the government or policymakers on an individual basis.

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