How Can Tax Cuts Help Revive the Economy
There are many opinions and predictions about how the economy will get back on track or how it will sink, and what should be the best approach of the government to take on this economic crisis. How important is the role of the government and how much a government should interfere in the economy? Introduction Unemployment has been one of the major concerns for many governments; historically unemployment reached 25% in the United States during the great depression in 1933. When there are no jobs people don’t have the money to spend, and demand for products decreases.
When demand decreases many companies go out of business or just hire fewer workers, while unemployment keeps growing. The government has a very powerful tool called fiscal policy to manipulate the economy and control and manage the levels of demand. Fiscal Policy Fiscal policy is based on the theories of John Maynard Keynes also known as the Keynesian economics. The theory of Keynes state that the government can influence the economy by manipulating the increase or decrease of taxes and at the same time the level of government spending.
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By controlling the level of government spending what fiscal policy can do is to change the position of the Aggregated Demand curve (AD), since Government (G) is part of the aggregated demand. At the same time the government could cut taxes putting more money into the pockets of consumers called “disposable income”, which is another way of busting the Aggregated Demand since Consumers (C) is also part of the Aggregated Demand. The Multiplier Effect
I think that there is a good question that we can formulate here: If government cut taxes and raises the level of government spending, how can the economy get better if by cutting taxes the government has less coming in, and at the same time by spending more the government is has more coming out? The multiplier effect states that when a part of the Aggregated Demand (C+I+G+(X-N) is changed, any of this components which usually is (G), the result is an increase even greater than what was originally impacted by the changed and by doing this the government could push out the Aggregated Demand curve according to this rule.
To explain the multiplier effect a little better let’s imagine that the government has 1 million dollars to spend, and it has several choices to do so, so let’s say that they decide to construct a new bridge. They hired 10 people who are now being paid and will spend part of that money each on another 10 more individuals. They spend 80% as disposable income and basic needs and save 20%. By spending 80% they are creating revenue for somebody else, who will use it as disposable money, at the same time by saving money they are creating more resources for a bank to e able to invest. At the end the initial money the government spent is not lost is only multiply and has created jobs, it has raised the level of demand, and it has boosted the (AD). The answer to the initial question: We can guess that the government expects to boost or better the economy by spending more, because eventually this spending will result into a greater impact into the economy by the consumers (C) Obstacles Reaching the Goals
Fiscal Policies have some obstacles that can make the goals very hard to reach, and it could reverse the process and create inflation if these policies are not monitored constantly. The way this could happen is if too much money is injected into the economy while taxes are still down, and the consumer demands for goods and services are lower than the production supply. The increase in economic productivity can cross over a very fine line devaluating the real value of money and pushing the prices up, hence inflation occurs.
At the same time the Multiplier effect can work in reverse because the success of the multiplier effect is based on the level of consumer spending. If the consumer doesn’t want to spend any money during difficult times there will be no money injected into the economy and the impact will be a decrease on the aggregated output. Conclusion The government plays a very important role in the economy, the decisions the government makes has a tremendous impact in the lives of its citizens.
Making smart decisions in an economy that seems very volatile and probably unpredictable is very difficult. I believe that by making tax cuts and spending which I would call (Investing) the government is making the right decisions because in the long run my generation is eager to be part of this economy and very soon become a big spender after I am done with school, after I graduate.
- Heakal, Reem. What is Fiscal Policy? Investopedia AForbes Digital Company File under: Bonds, Economics, Retirement URL Web Site: http://www. investopedia. com/articles/04/051904. asp
- Wikipedia: Fiscal Multiplier:URL Web site: http://en. wikipedia. org/wiki/Fiscal_multiplier Holden, Paj.
- Teacher of Economics:PajHolden’s Channel In Youtube fiscal policy and the multiplier effect URL
- Web Site: http://www. youtube. com/watch? v=0CjNlyiDAno New Law’s Tax Cuts Mean Extra Cash: IRS Web Site http://www. irs. gov/newsroom/article/0,,id=109816,00. html