Question a
- Economic growth
Economic growth is the aggregate positive change in an economy’s capacity to produce different goods and services. Economic growth is determined by comparing the economy’s productivity between two or more periods. The measure of economic growth can take different forms such as the real and nominal form. The nominal form of measuring economic growth includes inflation. The real terms of economic growth reflect figures that are adjusted for inflation. Economic growth of different nations can be compared using the gross domestic product or the gross national product per capita.
- Regressive taxes
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This is a form of taxation where the system of taxation imposes heavier tax burdens on the low income citizens of the country as compared to the high income group of the population. Generally, regressive taxes are applied in a uniform manner hence; the low income individuals in the economy suffer most while the rich enjoy.
Question b
The relationship between income tax rates and tax revenue was explained by an economist named Arthur Laffer. Laffer explained this relationship using a diagram named the Laffer curve. The curve demonstrates how tax revenues that are collected by the government relate with tax rates. According to Laffer, the relationship between the two factors can be divided into two main parts; the economic effect and the arithmetic effect. The Laffer curve is illustrated in the diagram below.
According to Laffer, as the taxes rise from low levels, the amount of tax revenues the government collects also increase. The curve shows that tax rates can only be increased to a certain level. Beyond the point T*, the tax rates cannot be increased because that increased would make the public less motivated. This move discourages people from working because most of their revenues would be taken away by government in form of taxes. This move would in the end lead to a reduction in tax revenues beyond point T*. Therefore, the government will always try to set the tax rate not beyond point T* to ensure that the public is motivated to work so that there is optimal tax revenue collection.
If the government raised its tax rates to 100% on the extreme right of the curve, no one in the population would be willing to work. This is because the tax rates are 100 percent hence; every penny of every employee is taken away by government as tax. Laffer argues that most governments try to set their tax rates at point T*. At that point, the government collects an optimal amount of taxes while the public are also motivated to work. Therefore, the point T* represents the optimal tax rate that a government can use to collect the highest amount of revenue possible. T* also represents the point where the public can contribute a large amount of revenue but still work hard. Therefore, the relationship between tax rate and revenue is positive up to the optimal tax rate point. Beyond the optimal tax rate, the relationship is inverse ; tax rate increase causes a reduction in revenue collected.
Question c
Income tax cuts are beneficial to an economy up to some given level. Small tax cuts have a positive impact on the prosperity and economic growth of the country. However, there is also another perspective where a reduction in the tax rate will benefit the rich members of society while the poor languish in suffering and poverty. In extreme cases, tax cuts have a adverse bearing on the economy.
When the income tax rate is set at a low level, the government will not raise sufficient revenue to sustain its needs and duties. The lack of sufficient funds for the government will also reduce its ability to fulfill its mandate in controlling the economy. The government will be unable to undertake monetary and fiscal policy processes if it does not have sufficient revenue to influence the amount of money in the economy.
Tax cuts will have a negative impact on the economy because it will have a distortion effect on the economy. When there are huge tax cuts, the public will have a lot of disposable income hence; there will be an inflationary effect in the economy. Furthermore, huge tax cuts are not good because they tend to benefit the top earners in the economy more than the low income earners. Therefore, the tax cut results in making the rich better off than the poor. It also causes inflation in the economy because of increased disposable income. Disposable income causes an increase in the demand for products.
However, income tax cuts are beneficial to the economy when they are introduced in small rates. The changes in the reduction must be small so that there is no impact on prices in the economy. Small tax cuts do not cause distortions but facilitate economic growth. This is because it encourages the public to work because of a low tax. The revenue collected by the government will also not reduce significantly to affect the national budget and spending. Therefore, income tax cuts are only beneficial to economic growth if they are small. Huge tax cuts cause distortions in the economy and promote inequality. The rich people will benefit more from the tax cuts than the poor. Tax cuts should not be used as a way of increasing economic growth. It should be used along with other fiscal policies to induce economic growth.
References
Larson, J. S. (2003). Tax Cuts: Issues and Analyses (illustrated ed.). New York: Nova Publishers.
