(DISCUSSION QUESTION) The House recently passed a plan to cut top corporate tax
ID: 1123768 • Letter: #
Question
(DISCUSSION QUESTION) The House recently passed a plan to cut top corporate tax rates from 35% to 20%. In order to partially pay for the tax cuts, congressmen are proposing to get rid of tax deductions for mortgage and student loan interest, charitable giving, and deductions for taxes already paid to state and local governments. Proponents argue that this will encourage long-run economic growth. Use the models and arguments we have discussed throughout the course to either support or critique these claims and determine the likely impact in the short-run and the long-run from the tax cuts. (Please focus on the economics of the tax cut).
Explanation / Answer
A corporate tax cut is an incentive to the business houses that is in line to the promotion of private property rights and an encouraging incentives to the firms. Though, the compensation of the loss by reducing the tax deductions to the individuals, reducing the charitable benefits to the poor communities other removal of tax deduction is not good for the economy. Hence, there is a doubt that the economy will gain from it.
It is the demand that creates supply and elimination of charitable benefits, tax deductions and other benefits causes the reduction in disposable income. The reduction in disposable income, reduces the aggregate demand that will lead to the aggregate supply even if the corporate tax has been lowered. Hence, in the short run, the economy will face a negative demand shock. The government can give the rational that lower corporate tax may lead to the reduction in prices that can compensate for the reduction in disposable income. But, the policy guidelines are not clear about it and in short run, prices are inflexible.
In the long run, the firms can build capacities using the corporate tax deduction and create a presence in the international market. Hence, the loss of domestic consumption will be compensated by the increase in investment spending and the increase in export. It can pull back the GDP to the earlier level, but at the cost of domestic consumption.
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