In: Economics
What is the argument conservative “supply siders” use to justify tax cuts that increase income inequality in the United States?
What does the evidence suggest about the validity of supply side theory. Connect your answer to the concept of growth in Potential RGDP.
Supply side economics refers to the macro economic theory that states that the economic growth can be most effectively created by lowering the taxes and decreasing the regulations. According to this theory, the consumers will then benefit from a greater supply of goods and services at lower prices which will lead to an increase in the employment generation. The Laffer curve is one of the main theoretical fact that supports this theory.
The income inequality can be measured in a supply side economic scenario both pre-tax and post-tax. An important side effect of the income tax cuts in the US economy is an increase in the post tax income inequality which means that those having higher incomes receives a greater share of the post-tax income. Since the Federal taxation represents a progressive method, cutting income taxes means relatively less is paid by the higher income generating households. It has also to be considered that almost 50% of the American households do not pay taxes as their income has not reached the level of paying these taxes. But over long period, it is being justified on the basis that it is not the income, but the wealth that creates inequality among the people of the US. Hence the tax cuts in general is considered to be not the only factor that contributes to the inequality among the people. Also a lower average tax rate offset the equalising effect of increased tax progressivity, leaving the effects of federal taxes on the income inequality unchanged.
The bigger the gap between the pre and post taxes, the higher will be the income inequality among the people. The gap which had narrowed in the 1980’s when the taxes relative to income fell more for high income households rather than low income groups have again widened in the recent decade. The conclusion is that the pre-tax income inequality has risen despite an increase in the government transfer payments. Connecting, the potential GDP may be defined as the level of output that the economy can produce at a constant inflation rate. It depends on the capital stock, potential labour force, demographic factors, participation rates etc. Thus based on the trickle down policy, greater tax cuts for investors and entrepreneurs provides incentives to save and invest and provide economic benefits that may trickle down in to the overall economy thereby resulting in an increased potential GDP growth.