Tax cut

A tax cut is a reduction in taxes. The immediate effects of a tax cut are a decrease in the real income of the government and an increase in the real income of those whose tax rate has been lowered. Due to the perceived benefit in growing real incomes among tax payers, politicians have sought to claim their proposed tax credits as tax cuts. In the longer term, however, the loss of government income may be mitigated, depending on the response of tax-payers. The longer-term macroeconomic effects of a tax cut are not predictable in general, because they depend on how the taxpayers use their additional income and how the government adjusts to its reduced income.

Depending on the original tax rate, tax cuts may provide individuals and corporations with an incentive investments which stimulate economic activity. Some politically conservative opinion-makers, such as Art Laffer, have theorized that this could generate so much additional taxable income that a lower tax can generate more revenue than was collected at the higher rate.

Economics

In Keynesian economics, a tax cut has the effect of increasing GDP via the fiscal multiplier. Theories which incorporate Ricardian equivalence such as the real business cycle theory however have tax cuts producing no or little change in national income. In these models, agents anticipate future tax rises to pay for government spending and cut their own spending. In New Keynesian economics, tax cuts give a greater stimulus to the economy than that of increases in government spending.

Tax cuts in the United States

In recent decades, most "supply-siders" in the United States have been Republicans (though a significant individual tax cut was proposed by President John F. Kennedy from the Democratic Party and passed by a Democratic Congress under another Democratic president, Lyndon B. Johnson) with the belief that cutting the tax rate would stimulate investment and spending, with overall beneficial effects (including replenishment of some lost tax revenues).

President Ronald Reagan signed tax cuts into law, which some believe stimulated a doubling in total tax revenues (from five hundred billion to one trillion dollars) during the period from 1980 to 1990. However, during this period the deficit and national debt more than tripled (from $908 billion in 1980 to $3.2 trillion in 1990) because government spending rose even faster than increases in tax revenue. As a result, income tax receipts as a percent of GDP fell from 11.3% in 1981 to 9.3% in 1984 and did not to revert to original levels until the late 1990s, even though overall revenue skyrocketed in terms of real dollars. Some supply-siders like Don Lambro of the Washington Times credit the Reagan tax cuts with the eventual surpluses of the late 1990s. Others doubt this claim however and instead believe the surpluses were a result of a combination of a decrease in government spending, the passing of the Omnibus Budget Reconciliation Act of 1993 (which dictated several tax increases), and the use of the PAYGO (pay-as-you-go) system. The Center on Budget and Policy Priorities and President’s Council of Economic Advisers argue that tax cuts do not pay for themselves stating that the "large reductions in income tax rates in 1981 were followed by abnormally slow growth in income tax receipts".

President George W. Bush signed two major tax cuts into law; one in 2001 and one in 2003. These are often collectively referred to as the "Bush Tax Cuts". The conservative think tank the Heritage Foundation has claimed that the Bush tax cuts have led to the rich shouldering more of the income tax burden and the poor shouldering less; while the Center on Budget and Policy Priorities states that the tax cuts have conferred the "largest benefits, by far on the highest income households." Bush is criticized for giving tax cuts to the rich and capital gains tax breaks, but some benefit extended to middle and lower income brackets as well. Bush has claimed that the tax cuts have paid for themselves but the Center on Budget and Policy Priorities argues that this is false. At the state level, former Democratic Governor Bill Richardson in recent years has supported tax cuts to spur economic growth.

Capital gains tax

Much discussion has occurred regarding the optimum capital gains tax rate, with some advocates calling for tax cuts in the belief that a lower rate (e.g., under 25%) will provide an incentive to investors to sell old stocks and invest in new stocks—which supply siders maintain encourages the creation of new jobs, reduces unemployment, and has the paradoxical effect of increasing tax revenues more or less immediately, an idea first proposed by economist Arthur Laffer while an advisor to Ronald Reagan (See Laffer curve).

See also

• Laffer curve
• Rahn curve
• Reaganomics
• Starve the beast
• Trickle-down economics
• S corporation

External links

• Congressional Research Service (CRS) Reports regarding U.S. tax cuts
• Advice for exchange students in the U.S. (J1 and F visas) on how to legally cut some taxes
• Cato Policy Analysis No. 242: The ABCs of the Capital Gains Tax
• Larry Kudlow on the Bush 2003 Tax Cuts and the U.S. Private Business Boom