Tax cut

Tax cut

A tax cut is a reduction in taxes. Economic stimulus via tax cuts, along with interest rate intervention and deficit spending, are one of the central tenets of Keynesian economics.

Economic theory

The immediate effects of a tax cut are not, generally, a decrease in the real income of the government and an increase in the real income of those whose tax rate has been lowered. In the longer term, however, the effect on government income may be reversed, depending on the response that tax-payers make. Depending on the original tax rate, tax cuts may provide individuals and corporations with an incentive for investments which stimulate so much economic activity that even at the lower rate more net tax revenue will be collected.Fact|date=October 2007

The longer term macroeconomic effects of a tax cut are not predictable in general, because they depend on how the taxpayers use their additional income and how the government adjusts to its reduced income. Three idealised scenarios can be hypothesised:

#Government cuts its expenditure, and taxpayers increase theirs, spending the money on commodities sourced from within the country. This combination is macroeconomically neutral, but advocates of a free-market economy argue that it improves economic welfare, since people are more accurate than the government in spending money on commodities that they actually want.
#Government maintains its expenditure (thus incurring debt), and taxpayers increase theirs, spending the money on commodities sourced from within the country. This combination provides a stimulus to the economy, and it is on these grounds that advocates of supply-side economics frequently argue for tax cuts. It should lead to economic growth, bringing about greater general prosperity, though unless managed carefully it will also lead to inflation. A government making tax cuts and incurring debt usually hopes that the economic stimulus of the tax cut will be large enough to produce a long-term increase in tax revenues, allowing the debt to be paid off in the future. If that does not occur then the government can be left with a severe budgetary crisis.
#Government maintains its expenditure (thus incurring debt), and taxpayers either save their increased income or spend it on commodities sourced from outside the country. This combination is not inherently deflationary, but it contributes to balance of payments difficulties which may have secondary deflationary effects and as noted above may lead to a government budgetary crisis with a painful readjustment to follow.

In practice it is likely that a mixture of these effects will occur, and the net effect of any tax cut will depend on the balance between them. It will therefore be a function of the overall state of the national economy. In conditions where most goods and services (especially those frequently purchased out of discretionary income, such as consumer durables) are produced domestically, a tax cut is more likely to provide a macroeconomic stimulus than in conditions where most consumer durables are imported. Furthermore, the actual effect will inevitably be difficult to discern, because of numerous other changes in the economy between the time when a tax cut is proposed and the time when its full effects would be realized.

If government does reduce its expenditure to accommodate tax cuts, there must necessarily be reductions in government services, and there may also be a reduction of the government's capacity to redistribute income to reduce income inequalities. Critics of tax cuts argue that this leads to a fall in overall economic welfare because the effects fall disproportionately on those with the lowest incomes.

Tax cuts in the United States

In recent decades, most "supply-siders" in the United States have been Republicans (though a significant individual tax cut was proposed by President John F. Kennedy from the Democratic Party and passed by a Democrat led congress) with the belief that cutting the tax rate would stimulate investment and spending, with overall beneficial effects (including replenishment of some lost tax revenuescite web| url= |title=Ten Myths About the Bush Tax Cuts| publisher=Heritage Foundation| last=Riedl |first=Brian |date=2007-01-29| accessdate=2007-07-17] ). President Ronald Reagan signed tax cuts into law, which stimulated a doubling in total tax revenues (from five hundred billion to one trillion dollars)during the period from 1980 to 1990.cite web| publisher=Mackinac Center for Public Policy |url= |title=Tax Cuts vs. Government Revenue| last=LaFaive| first=Michael| date=1997-11-01|accessdate=2007-07-19] However, during this period the national debt more than tripled (from $908 billion in 1980 to $3.2 trillion in 1990) this was due to the immense increase in spending during Reagan's tenure and probably is not a result of the tax cuts. [U.S. Treasury Historical Debt Outstanding [] ] Don Lambro of the Washington Times credits the Reagan tax cuts with the eventual surpluses of the 1990s. [cite web|url=|title=Budget myths and mischief|last=Lambro|first=Donald|publisher=The Washington Times|date=2004-02-04|accessdate=2006-02-17] The Center on Budget and Policy Priorities and President’s Council of Economic Advisers argues that tax cuts do not pay for themselves stating that the "large reductions in income tax rates in 1981 were followed by abnormally slow growth in income tax receipts".cite web| url= |title=Will the Tax Cuts Ultimately Pay for Themselves? |publisher=Center on Budget and Policy Priorities| last=Kogan |first=Richard |date=2003-03-03| accessdate=2007-07-19] The most recent federal tax cut of significance was derived from President George W. Bush. The Heritage Foundation has stated that the Bush tax cuts have led to the rich shouldering more of the income tax burden and the poor shouldering less; [cite web|url=|title=Ten Myths About the Bush Tax Cuts|publisher=The Heritage Foundation|last=Riedl|first=Brian M.|date=2007-01-29|accessdate=2007-02-12] however, Bush is often highly criticised for giving tax cuts to the rich.cite web|url= |title=Dems call for ending tax cuts for rich |publisher=USA Today |last=Welch |first=William |coauthors=Bello, Marisol |date=2007-07-01 |accessdate=2007-07-19] Bush has claimed that the tax cuts have paid for themeselves but critics argue that this is false.cite web|url= |title=Claim that Tax Cuts "Pay for Themselves" is Too Good to Be True |publisher=Center on Budget and Policy Priorities |last=Kogan |first=Richard |coauthors=Aron-Dine, Aviva |date=2006-07-27| accessdate=2007-07-19] At the state level, Democratic Governor Bill Richardson in recent years has supported tax cuts to spur economic growth. [cite web|url=|title=New Mexico cuts taxes to stimulate economy|publisher=United Press International|last=Magers|first=Phil|date=2003-02-19|accessdate=2007-02-12]

Capital gains tax

Much discussion has occurred regarding the optimum capital gains tax rate, with some advocates calling for tax cuts in the belief that a lower rate (e.g., under 25%) will provide an incentive to investors to sell old stocks and invest in new stocks -- which supply siders maintain encourages the creation of new jobs, reduces unemployment, and has the paradoxical effect of increasing tax revenues more or less immediately, an idea first proposed by economist Arthur Laffer while an advisor to Ronald Reagan ("See Laffer curve"). In addition, a recent report issued by the Cato Institute argues that the burden of capital gains tax is felt by the poor much more than the rich. The report quotes a painting contractor as saying: "You're looking at a poor man who thinks the capital gains tax cut is the best thing that could happen to this country, because that's when the work will come back. People say capital gains are for the rich, but I've never been hired by a poor man."While this paradoxical effect is clearly possible in principle, opponents of capital gains tax cuts are not persuaded that it occurs in practice. They therefore argue that the rate of capital gains tax should be raised, since it is paid primarily by the better off, who can afford to contribute disproportionately to government revenues.


External links

* [ Congressional Research Service (CRS) Reports regarding U.S. tax cuts]
* [ Cato Policy Analysis No. 242: The ABCs of the Capital Gains Tax]
* [ Larry Kudlow on the Bush 2003 Tax Cuts and the U.S. Private Business Boom]

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