Question

When the professional economists in the Trump administration calculated the benefits to household incomes based on increased wages associated with the reduction in the corporate income tax rate proposed by the administration, they were ridiculed because the total benefits to household incomes exceeded the amount of the tax cuts. Was this justified? Illustrate your reasoning graphically.

Hint: The corporate income tax is a tax on corporate profits and can be seen as a tax on the return on capital. This is known as the rental rate of capital and is the compensation the owners of capital used in the production process obtain.

(Please Use Supply and Demand Model to explain this Government Intervention)

Answer 1

Let's suppose the initial tax is T1. At this tax rate, the tax revenue is the area to the left of the T1 line. Both consumers and producers have to pay higher price and their is also deadweight loss which is area towards right to T1 till equilibrium of demand and suppy. Deadweight loss is the loss in social welfare due to market intervention such as tax.

When the taxes are reduced say to T2 tax revenue does down shown by purple region. This is the cost to the government because of undertaking a tax cut.

But this reduced tax has also lowered the deadweight loss represented by green area.

Now the benefit to household is the purple area (tax reduction) plus green area (reduced deadweight loss).

Therefore, clearly, the benefit to household is greater than the cost to the government.

Hence, it wasn't justified to ridicule the economists.