What is a potential effect of increased taxation on economic growth?

Increased taxation can deter investment and slow economic growth due to the way taxes affect individuals and businesses. When taxes rise, disposable income for consumers typically declines, which reduces their purchasing power. This can lead to decreased consumption, one of the primary drivers of economic growth.

For businesses, higher taxes can reduce their profit margins, leading them to be less incentivized to invest in expansion, new projects, or hiring additional employees. These decisions directly impact the level of investment in the economy; if businesses are holding back on investments due to higher tax burdens, the overall capacity for growth diminishes.

Additionally, uncertainty surrounding taxation can lead to a more cautious business environment where firms may delay or forgo investments, further contributing to a slowdown in economic activity. This relationship illustrates how tax policy can play a crucial role in shaping the economic landscape.