How do taxes affect the welfare and economic well-being of participants in a market?

Taxes play a critical role in the economy. The government tries to impose an optimum tax rate to foster economic development. A higher tax rate often hurts the economic well-being and welfare of participants in a market. Tax on goods that generates positive externality generally reduces market welfare. Tax discourages the producers from investing in the economy, resulting in an inefficient allocation of resources. The inefficient allocation of resources affects the economy as well as participants in economic activities.