Tax cut

From Wikipedia, the free encyclopedia
  (Redirected from Tax cuts)
Jump to navigation Jump to search

A tax cut is a reduction in the rate of tax charged by a government. 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 rates have been lowered. Due to the perceived benefit in growing real incomes among taxpayers, politicians have sought to claim their proposed tax credits as tax cuts.[citation needed]

They are usually used to end a recession, as a popular measure of expansionary fiscal policy.[citation needed] Nevertheless, how a tax cut affects the economy depends on the tax that is being cut. But in general, they boost the economy because they put more money into circulation. This is a good measure for improving the economy in the short term.[citation needed] However, this will increase the federal debt, depressing the economy in the long term.[1]

Types of tax cut[edit]

The different types of tax cuts correspond to the different types of taxes, but the most important are:

  • Capital gains tax cuts

Capital gains is a tax on the profits of the sale of an asset that has increased in value. A cut in capital gains tax 'reduces taxes on the sale of assets. That gives more money to investors'[citation needed] The tax is on the gain in money made from the investment, not the money that is received from the sale of the asset. For example, if 'You bought a painting for £5,000 and sold it later for £25,000. This means you made a gain of £20,000 (£25,000 minus £5,000)’[citation needed]. This can have a positive effect on the economy as it means investors have more money than they can then invest in other companies thus helping them to grow.

  • Income tax cuts

Lower-income tax rate increases workers' income because they would keep more of their gross income, they have more money to spend. Consequently, the aggregate demand would rise, leading to higher economic growth. However, cut in taxes lead to lower government revenue, but with the expected increase of productivity due to higher incomes, governments expect to compensate for the fall of revenues.[2]

  • Business tax cuts

The main purpose of this tax cut is to reduce taxes of companies, so the firms earn more money and they are able to invest more. This also can help entrepreneurs to start new businesses more easily. Furthermore, that extra income they earn with the tax cut can be used for investing in their own business, creating new jobs, leading to higher economic growth.[3]

Examples[edit]

Some of the notable examples of tax cuts, in the US, the last decade are:

  • Obama tax cuts - In order to limit the devastating effects of the 2008 crisis, congress passed the $787 billion American Recovery and reinvestment act, which included: income tax cuts of $400, lower payroll taxes, better-earned income tax credits, aid for families which have a child in college...[4] These tax cuts imposed by the president boosted the economic performance in the short-run and they helped the US citizens during the Great Recession
  • Trump tax cuts - Trump's administration lowered the corporate tax rate to 20%, while also lowering income taxes. It could be argued that these measures weren't effective as the economic performance in 2019 was equivalent to 2017 levels.

United States[edit]

  • Is easy to say that the government has spent too much money. But when the government decides to cut taxes, clearly a group of people is going to be harmed.[citation needed] Cutting taxes can lead to an increase in inequality because most of the money the government spends is destined to lower-income groups. For example, taxation in Europe is different from the US, having a much lower tax burden. However, even though they[clarification needed] have lower taxes they have to pay for health care. Paying more taxes can also make a country more efficient and equitable.[5]
  • In 2001, the Bush administration decided to design tax cuts focused on producing a short-term sense of confidence by putting more money in the pocket of business and investors, encouraging investment in the stock markets, all this doing nothing for the future. The evidence showed that this actually harmed the US economy. The only ones who benefited from this were the Americans that earned more of the 99.9% of the rest of the population, they got 12.5% of the tax cuts. For the other millions of Americans, this did not add overall spending or saving.[6]
  • What matters is the way the tax cut is structured and how this affects behavior. A bad structure tax cut can result in fewer jobs and more costs for society. However, if it is well structured it can help increase future prosperity. [7]

United Kingdom[edit]

Tax policy is an issue that has dominated UK elections for decades.[citation needed] The most significant tax cuts came in the 1980s under Margaret Thatcher. When Thatcher became Prime Minister in 1980 tax rates were relatively high. For example, income tax rates could reach as high as 98%[citation needed]. However, by 1988 Thatcher’s government had reduced the top rate of income tax to 40%. She also reduced the basic rate of income tax from 33% down to 25%.[citation needed] Her opposition to high levels of direct taxation also led to her cutting the Corporation tax rate. This is the rate that corporations are taxed on their profits over a certain level. When she entered office in 1979 ‘the standard rate of corporation tax was set at 52%’[citation needed]. During her tenure, she cut this rate significantly and when she left office the rate was 34%. In addition, she also cut the rate of corporation tax that is paid by small companies. Thatcher believed that by implanting policies of tax cuts that she would help improve the state of the economy. This is because by cutting the rate of taxation individuals have to pay on their income you are increasing the spending power of the consumers and can thus increase aggregate demand.[citation needed] As a result of this increase in spending the tax cuts can also result in higher levels of economic growth for the economy. Moreover, a cut in corporation tax will result in an increase in ‘the post-tax profits of business’.[citation needed] This can have a positive impact on the economy as companies have greater profits that can be reinvested into their firms, possibly in the form of employing more workers. Therefore, reducing the overall levels of unemployment in an economy. As well as this the increase in investment by firms funded by a cut in the amount of tax they have to pay can impact the productive capacity of the economy as a whole, or rather cause a rightward shift in the Long Run Aggregate Supply (LRAS) curve of the economy.[citation needed]

Definition[edit]

Tax cuts represent changes in the law that reduce the rate of taxes charged by the government. As a result, the real income of taxpayers rises, while the government debt increases. This expansionary fiscal policy can help boost the economy by increasing the real income of taxpayers and thus encouraging further economic activity. However, the long-term macroeconomic effects of a tax cut can generally not be predicted as they depend on the further usage of the taxpayers´ extra income and on the government´s dealing with the lowered income.

Types[edit]

Tax cuts occur in different forms and include loopholes, credits, or tax deductions.

Income Tax Cuts[edit]

Reduction in tax rates imposed on the income of individuals and families results in a greater disposable income and increase consumer spending, which is one of the four components of gross domestic product (GDP).

Capital Gains Tax Cuts[edit]

This type of tax cuts reduces tax rates imposed on sales of assets, which provides investors with more money and encourages them to buy further stock, thus boosting the growth of the companies. Another consequence is increased prices of gold, oil, real estate, and other assets.

Business Tax Cuts[edit]

Business tax cuts lower taxes imposed on a company´s profits, which leaves the company with more capital to invest in wages, growth, investment and hiring.

For startups, tax cuts provide entrepreneurs with more money to hire new workers and thus create private-sector jobs.

For corporations, the lowered corporate income taxes give them more money to reinvest in their businesses, which again helps to create jobs.

Payroll tax cuts help both businesses and employees as it reduces the amount paid to Medicare, Social security and unemployment taxes.

Reasons[edit]

There are several reasons why the government should cut taxes.

Deserved money[edit]

In a free country, the money belongs to the people who earned it and who possess the right to keep it. Obviously, there is a certain fraction of the wealth created that should be willingly given up in order to help finance such public necessities as education, a system of justice, or national defense. However, the government should only have a limited claim on how much money it wants to take and what uses it finds for the money.[citation needed]

Efficiency[edit]

When money gets into the hands of the government, there are sometimes overwhelming amounts spent by the state without any significant changes. Some government expenditures might seem disproportionately high as if the government did not endeavor to minimize expenditure costs. Opposed to that, private individuals and businesses spend their own money carefully and often more efficiently. They are likelier to aim to reach their desired level of utility at the minimum expenditure possible. To sum up this point, the same amount of money will be used more efficiently in the private sector than in the hands of the government.[citation needed]

Motivation[edit]

High taxes generally discourage work and investment.[citation needed] Taxes on income create a wedge between what the employee receives and what the employer pays. As a result, employers have higher expenditure with taxes and therefore create fewer jobs than they normally would. People get also discouraged from working overtime or from making new investments as when they exceed the marginal level of income, they are taxed at a higher rate. Some critics[who?] say that the current marginal rate of 37% in the US does not depress economic output as much as the 70% rates that taxpayers faced in 1980. [8]

The overall tax burden[edit]

The overall tax burden is quite high. As of 2020, the federal revenue was equal to 16% of the total gross domestic product in the US. [9]

Election[edit]

In terms of political strategy, promises on tax cuts played an important role in the previous presidential election in the US. In 1980, 1984 and 1988, Ronald Reagan and George Bush won three presidential elections by promising to cut taxes and then really cutting them. Opposed to that, George Bush raised taxes and lost the next election.

Historical Overview[edit]

Another way to analyze tax cuts is to have a look at their impact in the past. Tax cuts max be proposed by the president, however, he or she needs to convince Congress to change the tax law.

The following overview includes some of the best-known past tax cuts and their assumed impact, even though it is difficult to assign the change purely to this policy as governments typically use various tools during a recession.

John F. Kennedy[edit]

John F. Kennedy´s plan was to lower the top rate from 91% to 65%,[10] however, he was assassinated before implementing the change.

Later on, Lyndon Johnson supported Kennedy´s ideas and lowered the top income tax rate from 91% to 70%.[11] In addition, he reduced the corporate tax rate from 52% to 48%.

Consequently, federal revenue increased from 94 billion dollars in 1961 to 153 billion in 1968.

Ronald Reagen[edit]

President Reagan cut the top income tax rate in 1982 from 70% to 50%. https://files.taxfoundation.org/legacy/docs/fed_individual_rate_history_nominal.pdf The economy´s GDP increased as follows:[12]

● 1983: 4.6%

● 1984: 7.2%

● 1985: 4.2%

Followingly, in 1988, Reagan cut the corporate tax rate from 48% to 34%. [13]

George W. Bush[edit]

President Bush´s tax cuts were implemented to stop the 2001 recession. They took form in reducing the top income tax rate from 39.6% to 35%,[14] reducing the long-term capital gains tax rate from 20% to 15% and the top dividend tax rate from 38.6% to 15%. [15]

These tax cuts may have boosted the economy in the short term, however, the growth might have stemmed from other incentives as well.

2002: 1.7%
2003: 2.9%
2004: 3.8%
2005: 3.5%

Throughout 2001, the Federal Reserve also lowered the benchmark fed funds rate from 6% to 1.75%.

Apart from boosting the economy, these tax cuts increased the U.S. debt by $1.35 trillion over a 10-year period [16] and benefited high-income individuals as tax rates decreased by 4.1% for the top 1% of households against 2 % for other households.

Barack Obama[edit]

Barack Obama arranged for several tax cuts in order to end the Great Recession.

In February 2009, the $787 billion American Recovery and Reinvestment Act of 2009 was approved by Congress, promising $288 billion in tax cuts and incentives,[17] including:

● A payroll tax cut of 2% ● Health care tax credits ● Up to $10000 for families supporting their child through college ● A reduction in income taxes for individuals of $400 ($800 for couples) ● Improvements to Child Tax Credits and Earned Income Tax Credits

The Great Recession ended in July 2009 with the following economic growth:

● 2.6% in 2010 ● 1.6% in 2011 ● 2.2% in 2012

To prevent the fiscal cliff in 2013, President Obama extended the Bush tax cuts on incomes below $400000 for individuals and $450000 for married couples. Incomes at and exceeding the top income threshold were taxed at the rate of 39.6% (the Clinton-era tax rate), which was granted by the American Taxpayer Relief Act of 2012. [18]

Donald Trump[edit]

On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act, which reduced the corporate tax rate from 35% to 20%. [19]

Some of the changes included income tax rate cuts, doubled the standard deduction, and eliminated personal exemptions. For those who don´t get health insurance, the Obamacare tax was repealed. [20]

Consequently, the GDP growth rate increased by 0.7% in 2018, however, in 2019 it fell below the value it reached in 2017. In 2020, the GDP took a sharp downturn, which was likely caused by the COVID-19 pandemic in great part.

Effects on the economy[edit]

Lower-income tax rates increase the spending power of consumers and can increase aggregate demand, resulting in higher economic growth. Apart from that, income tax cuts may also increase incentives to work, thus incurring higher productivity.

In general, the tax cuts effects depend on the state of the economy, the way the tax cut is financed, and whether the cut prompts productivity and the willingness to work.[citation needed]

Income Tax Rate[edit]

With a reduced income tax rate, workers will see an increase in their discretionary income, they would keep more of their gross income and have more money to spend, thus resulting in increased spending.[citation needed] Increased consumer spending due to consumers being better off leads to a rise in aggregate demand (as it constitutes roughly 60% of AD), leading to higher economic growth.[citation needed] On the other hand, tax cuts will lead to lower tax revenue and likely cause higher government borrowing. Some economists[who?] believe this fall in revenue should be offset by the increase in productivity.

See also[edit]

References[edit]

  1. ^ "Tax cuts,types and how they work". The balance. Kimberly Amadeo. Retrieved 27 April 2021.
  2. ^ "The effect of tax cuts". Economics Help. Tejvan Pettinger. Retrieved 28 April 2021.
  3. ^ "Tax cuts,types and how they work". The balance. Kimberly Amadeo. Retrieved 30 April 2021.
  4. ^ Amadeo, Kimberly. "Tax Cuts, Types, and How They Work". the balance. Retrieved 30 April 2021.
  5. ^ "Disadvantages of tax cuts". Economics Help. Tejvan Pettinger. Retrieved 28 April 2021.
  6. ^ "Tax cuts can do more harm than good". Aljazeera America. David Cay Johnston. Retrieved 30 April 2021.
  7. ^ "Tax cuts can do more harm than good". Aljazeera America. David Cay Johnston. Retrieved 30 April 2021.
  8. ^ https://www.taxpolicycenter.org/statistics/historical-highest-marginal-income-tax-rates
  9. ^ https://datalab.usaspending.gov/americas-finance-guide/revenue/#:~:text=In%20Fiscal%20Year%202020%2C%20federal,that%20year%20(%2421.00%20trillion).
  10. ^ https://www.jfklibrary.org/learn/about-jfk/jfk-in-history/john-f-kennedy-on-the-economy-and-taxes
  11. ^ https://taxfoundation.org/happy-birthday-kennedy-tax-cuts/
  12. ^ https://fred.stlouisfed.org/series/A191RL1A225NBEA
  13. ^ https://www.taxpolicycenter.org/statistics/corporate-top-tax-rate-and-bracket
  14. ^ https://fas.org/sgp/crs/misc/RL34498.pdf
  15. ^ https://eml.berkeley.edu/~yagan/DividendTax.pdf
  16. ^ https://www.brookings.edu/wp-content/uploads/2016/06/200203.pdf
  17. ^ http://www.nyc.gov/html/ops/nycstim/downloads/pdf/human_services_council_presentation_mayors_office_of_operations.pdf
  18. ^ https://www.taxpolicycenter.org/briefing-book/what-did-american-taxpayer-relief-act-2012-do
  19. ^ https://taxfoundation.org/tax-basics/tax-cuts-and-jobs-act/
  20. ^ https://www.ncbi.nlm.nih.gov/pmc/articles/PMC5944881/

External links[edit]