Question

Some politicians and economists argue that tax cuts are beneficial for the government budget balance and are also beneficial for the economy in the short run and the long run. Explain their arguments and evaluate them briefly.

Answer 1

Some politicians and economists argue that tax cuts are beneficial for the government budget balance.

They argue so because as the tax cuts are introduced, aggregate demand in the economy increases which leads to increase in in employment, output and income in the Economy. As the incomes in the economy increase, at the decreased tax rate, there is now more revenue because the tax base has increased due to increase in income. So in this case decrease in tax rate leads to an increase in government revenue through the increase in income in the economy. Hence, tax cuts are beneficial for the government budget balance.

Moreover, tax cuts are beneficial for the economy in the short run because in the event of the recession, these tax cuts puts money in the pocket of people, leading to an increase in aggregate demand and output in the economy and thus bringing the economy out of recession. Hence, tax cuts are beneficial for the economy in the short run.

Since, the classical, the Keynesian and major school of thoughts consider the Long run Aggregate Supply Curve to be Vertical, tax cuts do not have any effect in the long run on the economy in general and the real variables in particular like output and employment. Hence, it cannot be said that tax cuts are also beneficial for the economy in the long run.