8/14/2019 Do Tax Cuts Stimulate The Economy.docx

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Do Tax Cuts Stimulate The Economy?

June 23 2010| Filed Under Auto Insurance,Corporate Tax,Economics,Fiscal Policy,

Government & Politics,Government Spending,Income Tax,Macroeconomics,Microeconomics,

Personal Tax,Retirement,Tax Policy,Taxes

Advocates of tax cuts argue that reducing taxes improves the economy by boosting spending;

those who oppose them say that tax cuts only help the rich because it can lead to a reduction in

government services upon which lower income people rely. In other words, there are two distinct

sides to this economic balancing scale.

The Tax System

The federal tax system relies on a number of different types of taxes to generate revenues. The

largest source of funds is the personal federalincome tax.According to theInternal Revenue

Service(IRS), approximately 43% of tax revenues are generated through this tax. Personal

income taxes are levied against income, interest, dividends andcapital gains,with higher earners

generally paying higher tax rates.

The second largest source of funds for the IRS, accounting for nearly 40% of total revenues, is

thepayroll tax.The payroll tax is a tax levied at a fixed percentage on salaries and wages, up to a

certain limit and is paid equally by both employer and employee. For 2007, the percentage is

6.2% of income up to $97,500, up from $94,200 in 2006. Payroll taxes have become an

important source of revenue for the federal government and have grown more quickly than

income taxes as the government has raised rates and income limits. Commonly known as the

FICA(the Federal Insurance Contributions Act) tax, the payroll tax is used to pay Social

Security benefits, Medicare and unemployment benefits. (For related reading, seeIntroduction

To Social SecurityandMedicare: Defining The Lines.)

The other major sources of revenues for the IRS are corporate taxes, comprising roughly 10% of

total taxes, andexcise taxes.Excise taxes are a form of federal sales tax, levied on miscellaneous

items such as gasoline and tobacco. They account for approximately 4% of the total tax revenue.

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8/14/2019 Do Tax Cuts Stimulate The Economy.docx

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A second concept is vertical equity, which is translated as the ability-to-pay principle. In other

words, those most able to pay should pay the higher taxes. An example of vertical equity is the

federal individual income tax system. The income tax is aprogressive taxbecause the fraction

paid rises as income rises.

The Optics and Emotions of a Tax Cut

Reducing taxes becomes emotional because, in simple dollar terms, people who pay the most in

taxes also benefit most. If you cut the sales tax by 1%, a person buying a Hyundai may save

$200, while a person buying a Mercedes may save $1,000. Although the percentage benefit is the

same, in simple dollar terms, the Mercedes buyer benefits more.

Cutting income taxes is more emotional because of the progressive nature of the tax. Reducing

taxes 25% on a family with anadjusted gross income(AGI) of $60,000 will save them

approximately $2,042. But a smaller 10% tax cut for a family with a taxable income of $150,000

would save them $3,333.

It seems that every politician who opposes tax cuts uses this imbalance to fight the cut. Tax

cutters are always open to the rich versus the poor argument. Even when tax cut proposals

eliminate the taxes altogether for lower income individuals, some critics still maintain the cuts

support the rich. This is true, in a sense, but if a tax cut generates broad-based increases in

disposable income, it is likely that people who pay the most in tax dollars will save the most. In

other words, those who do not pay taxes cannot benefit from a tax cut

A Taxing Decision

Another problem for tax cut advocates is balancing the budget. Cutting taxes, at least

theoretically, reduces government revenues, which creates a budget deficit. To counter this

deficit, the government could cut spending. However, critics of tax cuts would then argue thatthe tax cut is helping the rich at the expense of the poor. That said, cutting taxes generally

increases disposable income, which can boost consumer spending, directly enhancing GNP. If

tax cuts succeed in increasing economic growth, the rich and poor may both benefit.

Read more:http://www.investopedia.com/articles/07/tax_cuts.asp#ixzz2JLLRpPT9

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