The Impact of Tax Cuts on the Economy

THE IMPACT OF TAX CUTS ON THE ECONOMY
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The Impact of Tax Cuts on the Economy
Governments use different methods to boost economic growth and support the economic well-being of their citizens. One method that has been used to enhance economic growth has been tax cuts. However, there has been a debate on whether tax cuts, on both individual and corporate income taxes, promote significant long-term economic growth or if the effects are not as substantial. According to Gechert and Heimberger (2021, p.30), tax cuts have no significant effect on economic growth. Hope and Limberg (2022) add that tax cuts only benefit the rich, thus widening income inequality. However, some scholars, such as Zidar (2019, p.1465) indicate that tax cuts can only promote economic growth if they are applied to the bottom 90%. This paper will explore the effects of tax cuts on the economy in more detail.
What are Tax Cuts?
Tax rates are tax reforms that involve reducing the amount of tax paid to the government for revenue generation (Auerbach & Smetters 2017, p.13). Tax cuts are believed, in theory, to promote economic growth based on the premise that low tax rates would increase the income received by individuals after-tax, thus improving their ability to purchase more goods and services. In addition, it is believed that with increased after-tax income, there would be more funds for investments and savings and all of these would boost the economy (Auerbach & Smetters 2017, p.14). Tax cuts can also give people an incentive to work and increase overall productivity, although Auerbach and Smetters (2017, p.14) indicate that they can also decrease people’s need to work, invest and save because they have more after-tax income, thus lowering the economic activities.
Thus, tax cuts can only boost economic growth under specific circumstances. For instance, tax cuts can boost economic growth if the reduction in tax rates is accompanied by a reduction in unnecessary government spending (Auerbach & Smetters 2017, p.14). Such an approach would ensure the tax cuts are financed without cutting back on governments’ investments in the economy. However, if the tax cuts are accompanied by a reduction in government investment to finance the tax rate, there could be a reduction in output (Auerbach & Smetters 2017, p.14). As such, it matters how the tax cuts are financed and this should be put into consideration while investigating the impact of tax cuts on the economy.
Tax Cuts and the Economy
As discussed above, the purpose of tax cuts is to boost economic growth. However, tax cuts can affect economic growth through:
Increases After-Tax Income
When income tax is lowered, people receive higher after-tax income and this is expected to increase their spending, investments, and savings. Spending and investments increase economic growth. However, the increase in after-income tax through tax cuts does not have the same effects when applied to different economic groups namely the bottom 90 percent and the top 10 percent (Zidar 2019, p.1455). Specifically, tax cuts among the bottom 90 percent yield a higher economic growth while tax cuts on the top 10% do not yield sign...