Tax cut
A tax cut is a reduction in the rate of tax charged by a government, for example on personal or corporate income. Whether a given tax cut will increase or decrease total tax revenues is much discussed by both economists and politicians.
Related Topics:
Tax - Government - Income - Revenue
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The immediate effects of a tax cut are, generally, a decrease in the real income of the government and to increase the real income of those whose tax rate has been lowered. In the longer term, however, the effect on government income may be reversed, depending on the response that tax-payers make. Supply-siders argue that tax cuts for corporations and wealthy individuals provide them an incentive for investments which stimulate so much economic activity that even at the lower rate more net tax revenue will be collected.
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Some economists argue that even in the short term cutting some taxes, for example capital gains tax, may raise government income immediately due to long-postponed sales of securities being made at the lower rate.
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The longer term macroeconomic effects of a tax cut are not predictable in general, since they will depend on what the taxpayers whose rate has been cut do with their additional income, and how the government adjusts to its reduced income. Four idealised scenarios can be hypothesised:
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- Government cuts its expenditure, and taxpayers increase theirs, spending the money on commodities sourced from within the country. This combination is macroeconomically neutral, but advocates of a free-market economy argue that it improves economic welfare, since people are more accurate than the government in spending money on commodities that they actually want.
- Government maintains its expenditure (thus incurring debt), and taxpayers increase theirs, spending the money on commodities sourced from within the country. This combination provides a stimulus to the economy, and it is on these grounds that advocates of supply-side economics frequently argue for tax cuts. It should lead to economic growth, bringing about greater general prosperity, though unless managed carefully it will also lead to inflation. A government making tax cuts and incurring debt usually hopes that the economic stimulus of the tax cut will be large enough to produce a long-term increase in tax revenues, allowing the debt to be paid off in the future. If that does not occur then the government can be left with a severe budgetary crisis.
- Government cuts its expenditure, and taxpayers either save their increased income under their mattresses, or spend it on commodities sourced from outside the country. This combination has a deflationary effect on the country's economy, and could lead to balance of payments problems, though it will tend to expand the economies of the countries sourcing the commodities that people purchase. However, if saving predominates over the purchase of imports, there may be an indirect stimulus to the economy because the additional supply of capital tends to reduce the interest rate.
- Government maintains its expenditure (thus incurring debt), and taxpayers either save their increased income under their mattresses, or spend it on commodities sourced from outside the country. This combination is not inherently deflationary, but it contributes to balance of payments difficulties which may have secondary deflationary effects, and as noted above may lead to a government budgetary crisis with a painful readjustment to follow.
In practice it is likely that a mixture of these effects will occur, and the net effect of any tax cut will depend on the balance between them. It will therefore be a function of the overall state of the national economy. In conditions where most goods and services (especially those frequently purchased out of discretionary income, such as consumer durables) are produced domestically, a tax cut is more likely to provide a macroeconomic stimulus than in conditions where most consumer durables are imported. Furthermore, the actual effect will inevitably be difficult to discern, because much else will have changed in the economy between the time when a tax cut is proposed and the time when its full effects should be felt.
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In the United States in recent decades, most "supply-siders" have been Republicans (though the largest individual tax cut was initially proposed by President Kennedy), and both President Ronald Reagan and President George W. Bush are well known for signing tax cuts into law, in the belief that cutting the tax rate would stimulate investment and spending, with overall beneficial effects -- including increased tax revenues. President Reagan's tax cuts were indeed followed by increased growth and substantial job creation. However, real (inflation-corrected) tax revenues dropped from 1981 to 1983 and did not surpass their 1981 level until 1985 (as shown in Table 1.3 in the Historical Tables of the 2006 U.S Budget). http://a255.g.akamaitech.net/7/255/2422/23feb20050900/www.gpoaccess.gov/usbudget/fy06/pdf/hist.pdf Even this recovery was arguably helped by the Tax Equity and Fiscal Responsibility Act of 1982, the Social Security Amendments of 1983, and the Deficit Reduction Act of 1984, all of which were estimated to have a positive effect on revenues. http://www.ustreas.gov/offices/tax-policy/library/ota81.pdf In addition, the federal deficit grew from 2.6% of GDP in 1981 to 6.0% of GDP in 1983. It began shrinking steadily after 1992, becoming a surplus in 1998. However, this was after tax bills in 1990 and 1993 which raised the top marginal tax rate. http://www.ustreas.gov/offices/tax-policy/library/ota81.pdf Despite all of this apparent evidence to the contrary, there are some who credit the Reagan tax cuts with the eventual surpluses of the 1990s http://www.washtimes.com/commentary/20040204-084711-8539r.htm Democratic Governor Bill Richardson in recent years has supported tax cuts to spur job growth. The most recent tax cut derived from George Walker Bush. Empirically, Bush's economic efforts have produced the most detrimental presidential tax cuts to date. It has effectively widened the gap between the both ends of the financial spectrum. The average annual income for the lower 25% has decreased by 10 percentage points, while the average income for the upper 5% has increased by 15 percentage points. This particular example often serves as rhetorical ammo for the liberal economists who advocate cutting taxes for ordinary people.
Related Topics:
United States - Republicans - President Kennedy - Ronald Reagan - George W. Bush - 1990 - Bill Richardson - George Walker Bush - Liberal
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If government does reduce its expenditure to accommodate tax cuts, there must necessarily be reductions in government services, and there may also be a reduction of the government's capacity to redistribute income to reduce income inequalities. Critics of tax cuts argue that this leads to fall in overall economic welfare because the effects fall disproportionately on those with the lowest incomes.
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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). While this paradoxical effect is clearly possible in principle, opponents of capital gains tax cuts are not persuaded that it occurs in practice. They therefore argue that the rate of capital gains tax should be raised, since it is paid primarily by the better off, who can afford to contribute disproportionately to government revenues.
Related Topics:
Capital gains - Laffer curve
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Latest news on tax cut
The £21bn tax gamble
Alistair Darling yesterday gambled the government's political future on a "spend now, pay later" £21bn package of tax cuts and spending increases designed to lift the economy out of recession by next summer.Insisting that he was not prepared to ignore the suffering of families in "exceptional circumstances", the chancellor said in his pre-budget report that he would borrow £78bn this year and £118bn next to fund a 13-month VAT holiday, cuts in income tax, more generous payments to pensioners and parents, and a £3bn boost to infrastructure.Darling promised to kick-start the economy by bringing forward both consumer and public spending, but admitted that it would take the government the length of the next parliament and more to restore the public finances to health through a much tougher than planned clampdown on public spending growth and increases in taxes.In what was being seen in Westminster last night as the death knell of New Labour and a return to a form of traditional left-right politics, Darling became the first chancellor since the 1970s to announce income tax increases, and also scrapped Gordon Brown's fiscal rules to sanction a doubling of borrowing this year. His statement caused a row with the opposition over borrowing and tax as the parties drew up clear battlelines for an election that has to take place by the spring of 2010, by which time it should be clear whether Labour's gamble has paid off.The chancellor said: "Because of the wide-ranging measures I am announcing today and the many strengths of the British economy, I am confident that the slowdown will be shallower and shorter than would been the case. If we did nothing, we would have had a deeper and longer recession, which would cost the country more in the long term."George Osborne, the shadow chancellor, said the measures would double the national debt to £1 trillion and leave a "tax bomb" ticking under the public purse. "The chancellor has just announced the largest amount of borrowing ever undertaken by a British government," he said. "To pay for it he has placed a huge unexploded tax bombshell timed to go off underneath the future economic recovery." Treasury forecasts for the economy over the next two years appeared to rule out a snap election next summer. Even on the chancellor's upbeat assessment, growth is expected to continue to decline in both the first and second quarters of 2009, with the expected pick-up in activity in the third quarter not showing up in the official figures until October 2009.Darling said it would be "perverse" to stick to Gordon Brown's fiscal rules after being forced to rip up his budget forecast of 2.5% growth and lower borrowing next year, but stressed that once the economy starts to recover, the Treasury will launch a five-year programme to reduce the ballooning deficit. The chancellor unveiled a clampdown on public spending growth, increases in the top rate of income tax to 45p for those earning more than £150,000, and a 0.5% rise in national insurance contributions costing everybody earning more than £20,000 a year around £3 a week from April 2011 onwards.Labour said that only those earning more than £40,000 a year would end up paying more as a result of the national insurance changes, but the Conservatives said the claim was only valid if Darling's decision yesterday to make permanent the increase in personal allowances to compensate taxpayers for the abolition of the 10p tax band is taken into account.Early reaction in the City was positive, with the FTSE 100 extending an earlier rally to post an increase of almost 10% - the biggest one-day percentage rise in its history. Analysts were, however, lukewarm about the stimulus package, warning that it might not be enough to spare the economy from a deeper and longer recession than the government expects. The chancellor said the 2.5% cut in VAT to 15% would last for 13 months and form the centrepiece of a recovery programme which will pump £9.2bn into the economy in 2008 and a further £16.3bn in 2009-10. The government had already pencilled in tax giveaways of £4bn for the two years, leaving a net injection of £21bn.The fiscal boost will come too late to prevent the economic contraction that began in the third quarter of this year continuing for a further nine months, the chancellor said, but would help to prompt recovery in the middle of next year and limit the fall in output to just 1%. Inflation is expected to fall rapidly next year, with the measure used by most pay bargainers - the retail prices index - registering an annual drop in prices of 2.5% next autumn.Tax increases, efficiency savings in the public sector, and lower capital spending will result in a tightening of policy worth almost £5bn in 2010-11 and a further £7.5bn in 2011-12. Public spending growth will be pared back from 1.8% a year to 1.2% - the lowest increases since Labour's first two years in office in the late 1990s. Significantly, the Tories, focusing on the projected borrowing figures, said they would not fall into the trap of opposing the new 45% rate of income tax, adding that it would not be a priority to reverse the measure if they came to power in 2010.Pre-budget report 2008Economic policyTax and spendingAlistair DarlingTaxIncome taxConsumer affairsRetail industryEconomicsRecessionCredit crunchPublic services policyguardian.co.uk © Guardian News & Media Limited 2008 | Use of this content is subject to our Terms & Conditions | More Feeds
PreBudget report: 10p tax losers still not fully repaid by Chancellor Alistair Darling
The emergency tax cut first introduced to compensate losers from Gordon Brown's 10p tax debacle was made permanent in the preBudget report.
Tories propose business tax cuts
David Cameron has unveiled proposals to cut the tax burden for employers as the main parties fight it out over tax.
Gordon Brown hints at tax cuts
Gordon Brown today suggested the government will announce tax cuts in the forthcoming pre-budget report to push the UK out of recession.In an interview with GMTV this morning, the prime minister said: "What I am determined to do is to get all countries around the world trying to get their economies moving again and one way you can do that is by putting more money into the economy by tax cuts or by public spending rises," he said."That's something that we've got to look at in the next few weeks."At the weekend the Financial Times reported that ministers were drawing up an emergency package of tax cuts. It said that, according to experts, cuts would have to be worth about £15bn to have much effect.Government sources have played down the prospects of tax cuts on that scale, although Brown's words today suggest that a significant package is being prepared.Brown also said the pre-budget report was coming "in the next few days". One report today said it would be unveiled next week.Brown has made clear he does not want to cut public spending so any tax cuts are likely to have to be funded from borrowing.The Conservatives have attacked that approach ? warning it risked pushing up interest rates and requiring tax rises once the economy recovered."He's talking about borrowing even more. And what does that mean? The risk of higher interest rates ? and mortgage bills ? and higher taxes to pay off the debt tomorrow," party leader David Cameron said at the weekend.The opposition is expected to announce plans tomorrow for tax cuts funded from savings in government spending.No details have been confirmed but reports suggest they will involve scrapping National Insurance payments for new workers to make it easier for employers to take staff on.The Liberal Democrat leader, Nick Clegg, whose party promises tax cuts for most people paid for by extra levies on high earners and higher green taxes, told Sky News the government would be "playing smoke and mirrors with the British electorate" if it promised tax cuts paid for by borrowing."You are in effect saying we will give you tax cuts today which you have to pay for tomorrow. That is wrong. You need permanent, big tax cuts."The answer was to close "multi-billion pound tax loopholes" exploited by the super-rich, he said.Brown will use his foreign policy speech tonight at the Lord Mayor of London's banquet at Guildhall to say the summit of the G20 biggest world economies must establish consensus on a new Bretton Woods-style framework for the international financial system, featuring a reformed International Monetary Fund which will act as a global early-warning system for financial problems.Following last month's co-ordinated international moves to refinance the banks and slash interest rates, Brown will say it offers "the chance to forge a new multilateralism that is both hard-headed and progressive".And he will outline five great challenges facing the world: to win the battle of ideas for democracy over extremism and terror; strengthen the global economy; tackle climate change; resolve conflicts and rebuild fragile states; and meet the UN's Millennium Development Goals."In Washington this weekend, the British government will work with its G20 partners to establish that consensus and with it to begin to build a new Bretton Woods with a new IMF that offers, by its surveillance of every economy, an early warning system and a crisis prevention mechanism for the whole world."My message is that we must be: internationalist not protectionist; interventionist not neutral; progressive not reactive; and forward-looking not frozen by events. We can seize the moment and in doing so build a truly global society," he will say.Brown's arrival will be greeted by anti-poverty and environmental protesters urging him to call time on the global greed which they hold responsible for the financial crisis.Gordon BrownTax and spendingEconomic policyTaxguardian.co.uk © Guardian News & Media Limited 2008 | Use of this content is subject to our Terms & Conditions | More Feeds
Brown raises tax cut speculation
Gordon Brown says tax cuts are among things being looked at for the pre-Budget report, which is due "in the next few days".
Tax cut prospect mulled in papers
The prospect of tax cuts to help people in the economic downturn - raised last week - whets a few appetites in the Sunday papers.
Brown may cut taxes to boost ailing economy
No 10 signalled yesterday that Gordon Brown may be willing to follow the cuts in interest rates by sanctioning tax reductions in the UK, as part of an internationally coordinated effort to give world economies a boost.The prime minister's spokesman referred to action already taken in Britain to cut personal taxes in the wake of the abolition of the 10p tax band, and appeared to suggest fresh measures are under active consideration to stave off recession. Brown will go to an emergency EU summit in Brussels today to press for an EU-led fiscal stimulus package. The spokesman said: "With action taken on monetary policy, it is becoming incredibly clear that there is now an emerging consensus across the developed world of the need to use fiscal policy in tandem with monetary policy to support growth. This is a point the prime minister will be making tomorrow and in the days ahead."He added that Brown "believes that this is a decisive moment for the world economy". No 10 insisted the remarks should not be seen as a definite sign that the chancellor, Alistair Darling, will offer further tax cuts in the pre-budget report, due in the next few weeks.Brown cut some taxes by £2.7bn this year as compensation for the abolition of the 10p rate, but yesterday's remarks suggest further cuts are being considered, even if it means borrowing more. The government could also boost the economy through capital spending programmes, but arguably not quickly enough to help the UK through 2009. The Conservatives have already said they believe Brown is planning tax cuts before the election.Brown's spokesman referred approvingly to packages being promoted by Germany and in the US by Barack Obama, who has proposed $80bn in tax breaks mainly for poor workers and elderly.Gordon BrownTaxInterest ratesCredit crunchEconomicsguardian.co.uk © Guardian News & Media Limited 2008 | Use of this content is subject to our Terms & Conditions | More Feeds
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