How can tax cuts help revive the economy Explain - Essay Example

Tax Cuts Tax cut means reduction of tax payers’ tax. Tax cuts lead to a decrease in the government’s real income and an increase in the tax payer’s income in the short run. The long-term effects of tax cuts on the government’s income depend on tax payer’s response according Michael (1997). Tax cuts, based on original tax provide incentives to individuals and corporations that can further be used to expand investment thus stimulating the economy. The government can then tax the new investments, which are more than the tax cuts, hence more taxable income and consequently increased government revenue than that which could be collected at higher tax rates.

The effect of tax cuts on the macro economy will however depend on the way the taxpayers will use their additional income and adjustment of government to its low income. This is referred to as fiscal policy which contrasts the macroeconomic policy which attempts to control interest rates as well as supply of money in stabilizing the economy. Fiscal policy uses taxation and government expenditure as its two instruments. Changes in taxation levels and government spending impacts on aggregate demand and economic activity level in the economy.

It also impacts on pattern of allocation of resources and income distribution. Fiscal policy is used by government to influence economic aggregate demand in the need to achieve price stability, economic growth and full employment. According to Kogan, (2003), tax cuts stimulate the economy together with intervention of interest rates and deficit spending. Economic stimulation can only be realized if the government reduces its expenditure and the tax payers increase their expenditure especially on local commodities.

The free market economy advocates argue that economic welfare of people will be improved since people are rational in what they want than the government.The suppliers of economy advocate for tax cuts because they stimulate the economy if the government expenditure is maintained and tax payers spend more of their income on locally produced commodities. This stimulates the economic growth but only on condition that it is properly maintained, otherwise it leads to economic inflation. If the expected revenue increase in the long term is not realized, the government may be left with huge debts to pay and hence a dangerous budgetary crisis.

In order that the government determines that the tax cut is or is not worth to the economy, the tax multiplier is used, which measures aggregate production changes as a result of government tax changes. Reflection of tax multiplier is that changes in tax does not equal change in aggregate expenditure. The tax payers may spend their increased income on foreign goods or save it. In such case, the government may have to readjust its budget otherwise incur balance of payment difficulties.Conclusion Tax cuts are an effective policy of stimulating economic growth but for them to be effective, tax payers must increase spending of the increased income on consumption of local products as consumption of imports will make balance of payment unfavorable.

On the other hand, they should invest the increased income so that the government can increase its tax revenue because saving it will reduce government tax income and hence inflation.References Kogan R. (2003) Will the Tax Cuts Ultimately Pay for Themselves? Center on Budget and Policy Priorities.http://www.cbpp.org/3-3-03tax.htm. Retrieved 2007-07-19.Lambro, D. (2004).Budget Myths and mischief. Washington.DC.The Washington Times.Michael.L. (1997). Tax Cuts vs. Government Revenue.Washington.DC.

Harvard University Press. .