Impact of Tax Cuts on the US Economic Growth - Essay Example

? Macroeconomics The article selected for the project is “Do Tax Cuts Leads to Economic Growth” (Leonhardt, . The article is focused on the US economy and described about the impacts of tax cuts on the economic growth. The article is written in technical language of economics and it seems that the author has conducted an in depth analysis on the US Economy. Following is the evaluation of the article. 1. Principles of Economics & US Tax Cuts The article has beautifully covered the different economic indicators along with their projected movements on the basis of the proposed strategy by the current Govt. The author has identified, as well as, analyzed the impact of tax cuts by taking into consideration of the different economic theories. In order to justify the arguments mentioned in the article, the author has used different economic theories. Equilibrium Theory of Economics: The author of the article implicitly described that the political leaders believe that the equilibrium in the economy will be achieved with the help of tax cut strategy. The assumption that lies behind the strategy of tax cut was that by reducing the taxes the economy will grow further and the economy may be able to achieve equilibrium position. First of all, it is important to develop cognizant regarding the equilibrium theory. Equilibrium theory of economics depends upon the behavior of demand and supply along with the prices of the whole economy (Scarf, 2008). The combination of quantity and the prices, where demand equals supply, is referred to as the equilibrium point. This equilibrium point is the point, where the economic growth is at its peak. The strategy, which is being followed by the US Govt. since last 10 years, was to reduce the taxes so the purchasing power of the people can be increased and the economic growth can reach approximately at its peak. Implicitly, the Govt. of United States Of America is assuming the equilibrium theory of economics persists. Therefore, the tax cut strategy should have been successful, but the reality is totally different from the presumed causation effect. The American economy was not healthy even before the financial crises that could be seen in 2007 and onwards. The economy became worsen even after the financial crises. The strategy of tax cut prevails throughout the period. Now the question arises why the tax cut strategy could not be successful? The answer lies in the explanation of Keynesian Theory of Economics. Keynisian Theory Of Economics: One of the most significantly studied economic theories by the author of the article is the Keynesian theory. The Keynesian theory describes the fact that there are number of different factors that must be considered when studying the cause and effect relationships (Keynes, 2004). The article has beautifully described the facts that during the period of tax cuts the economy could not grow properly, but the period of economic growth could be significantly seen when the tax rates were high David Leonhardt, the author of the article has conducted the correlation analysis. The basic concept behind the Keynesion economic theory is that the aggregate demand and supply may never be equal for the economic growth. In other words, the equilibrium point, where the demand equals supply may not necessarily be the point of highest economic growth. The reason is that there are many other factors that may have profound impacts on the economic growth. The US Govt. must also consider those other factors to define the economic growth. The basic presumption behind the tax cut strategy, was that in short term the tax cut put money in the people’s pocket and in the long run people will work harder if they keep more of the next dollar they earn. The Govt. did not focus on other related and important factors. One of the most important considerations was that the people who care about hitting the specific income target might work less because they can hit that particular income target more easily. In addition to this, the economy has also experienced deficit, which may be the reasons of other economic problems. The Keynesian Theory is further refined with the inculcation of Neoclassical Theory Of Economics that may help in evaluating the article more appropriately Neo Classical Theory of Economics: The Theory determines the prices, outputs and income distributions with the help of supply and demand. The theory is often mediated through the maximization of utility by those individuals who are income constrained and profits by those firms who are cost constrained (Weintraub, 2007). The major impact of Neo Classical theory is that it dominates the microeconomics. Another important consideration of Neo Classical theory is that the theory along with the Keynesian concepts of economics forms the synergies known as Neo Classical Synthesis. The author also identifies that the appropriation prices, output and income distributions in proper manner while considering all the factors that may have negative or positive impacts on the economic growth must be considered. 2. Identification of Macroeconomic Indices: The Article has focused on different macroeconomic indices. One of the most important macroeconomic indices is the GDP Growth rate. The GDP Growth rate reflects the economic growth of the country. The article is focused on the correlation analysis between the economic growth rate and tax cut. The author of the article is focused on the point that the GDP growth rate is impacted by the Macroeconomic Indices (Sullivan, Steven & Sheffrin, 2003). Following are some important macroeconomic indices that may have implicit impacts on the economic growth of the United States of America 1. GDP growth rate 2. Tax Revenue to GDP 3. Consumer Price Index 4. Wholesale Price Index 5. Balance of trades 3. Definition & Explanation for Indices: a). GDP Growth rate: The Tax cut may have both positive, as well as, negative impacts on the economy. After the tax cut the prices of the products may be reduced the inflation may have positive impacts exports may be increased because the demand for the cheaper goods is increased. Theoretically explained, the ultimate impact may be positive by reducing the tax rates, which may lead to positive GDP growth number. Realistically, the GDP growth rate is reduced because the people, who have set the target of achieving the particular income slab, can now achieve it in easier terms. Therefore, the real impact on the GDP growth rate is negative. b). Tax Revenue to GDP: From theoretical perspective, tax revenue to GDP ratio should be reduced because of positive impacts on GDP growth rates and reduction in tax revenues. The Actual impact may be ambiguous, because both the GDP and Tax revenue figures may have been reduced. Therefore, it is important to understand, which factor has been affected more. c). Consumer Price Index: The Consumer price index is one of those macroeconomic indices, which may help in defining the overall performance of the economy. The consumer price index describes the inflation number based on the predefined consumer baskets of goods. The prices of the goods, which are included in consumer basket, may be reduced due to the tax cut, but as mentioned in the article that the people will put less effort to earn the same amount of money. Therefore, the GDP may reduce and the Inflation may increase. d). Wholesale Price Index: The Wholesale price index also defines the inflation number but the basket of goods that is considered while developing the wholesale price index is based on the prices of whole sale products. Theoretically, the tax cut may also have positive impacts on the prices of the goods. Pragmatically, this is not the case. In developing the monetary policy statement of the country, the consumer price index has been given more weight age than the wholesale price index because the impacts on ultimate consumers may also have incorporated the wholesale prices. If the GDP is declining because of tax cut then practically the WPI will also be decreased. e). Balance Of trade : The balance of trade refers to the exports and imports. The Net impact of exports and imports on the country refers to the balance of trade. The exports of the country are impacted by the prices of the domestic products, as well as, the international products. The reduction in domestic prices leads to the increase in demand for the domestic products in the international market. The Increase in demand leads to an increase in exports of the country. Therefore, reduction in tax of the country may lead to an increase in the exports of the country and ultimately balance of trade may be positive. On the Other hand, the imports may have opposite impacts. Imports of the country are highly correlated with the inflation of the other countries along with the importer’s own country. Reduction in the prices of the other country’s products due to lowering their inflation number, the demands for the products may be increased, which may lead to an increase in imports of the products. Similarly the prices of the domestic products also have profound impacts on the imports of the country. If the tax rates are low in the country, people will have more money to consumer and spend. Therefore, the demand for the imported products will be higher, which may ultimately have negative impact on the balance of trade. Now the question arises, whether higher imports always lead to negative impacts on the economy or not? The answer lies in the fact that if imports are for the purpose of future developments then despite of the short run negative impacts on the country’s economy, in the long run it will definitely have positive impacts on the economy. On the contrary, if the imports are only due to increase in consumption the ultimate impacts on the economy may be negative. 4. Relationship between the Tax Cut and the Macroeconomic Indices: The relationship between the tax cut and macroeconomic indices has already been studied in the explanation and definition section of the paper, but in bifurcated way. This section discusses the relationship between the tax cut and macroeconomic indices in general terms. The article clearly motions the fact that the tax cut strategy in the United States of America, has proved to be unsuccessful strategy. The reason behind the failure of tax cut strategy is that the govt. could not be able to focus on other factors that in combination with the tax cuts may lead the economy towards the declining trend. Therefore, it is important to understand, which of the macroeconomic indices may have most significant impact on the overall economy. The GDP growth rate is one of those macroeconomic indices, which may help in defining the overall economic growth of the country (Ayres, 2006). As mentioned above the GDP rate refers to the production of goods and services within the geographic boundaries of the country. Therefore, all the production, which is done within the country, no matter if it is produced by the resident or non-resident of the country, the GDP defines the economic growth. Other macroeconomic indices such as CPI, WPI, balance of trades all of them have profound impacts on the US economy if these indices are explained in combination of tax cut factor. 5. Evaluation, Decision & Forecast: a) Evaluation The article on “Do tax cut lead to Economic Growth” by David Leonhardt, implies that the tax cut has negative impact on the overall economy. The reason is supported by the trend analysis conducted by the author for the topic under consideration. Therefore, it is important to understand the perception of the author before, taking any decision. b) Decision: The ultimate decision that can be drawn from the article is that for economic growth it is important to understand the Keynesian concept of incorporating other factors, so the real economic growth can easily be defined c) Forecast: If the current scenario persists along with the Keynesian theory of economics, which forecast that the tax cut strategy should not be followed otherwise the eventual impact on the economic growth rate will not positive. References Ayres, R. U. & Benjamin, W. (2006) Economic growth, technological progress and energy use in the U.S. over the last century: Identifying common trends and structural changes in macroeconomic time series, INSEAD. Retrieved from http://www.insead.edu/facultyresearch/research/details_papers.cfm?id=16670 Keynes, J. (2004) The economic consequences of the peace . New Brunswick: Transaction Publishers. Leonhardt, D. (2012) Do tax cuts lead to economic growth?. New York Times, Retrieved from http://www.nytimes.com/2012/09/16/opinion/sunday/do-tax-cuts-lead-to-economic-growth.html Scarf, H. (2008) "Computation of general equilibria," The New Palgrave Dictionary of Economics, Retrieved: http://www.dictionaryofeconomics.com/article?id=pde2008_C000573&q=computational%20economics&topicid=&result_number=3 Sullivan, A. & Steven M. S. (2003) Economics: Principles in action. Upper Saddle River, New Jersey: Pearson Prentice Hall. Weintraub, E. (2007) Neoclassical economics: The concise encyclopaedia of economics. Retrieved from http://www.econlib.org/library/Enc1/NeoclassicalEconomics.html Read More