Gross national product GNP , a measure of a nation's wealth, is also directly affected by federal taxes An easy way to see how taxes affect output is to look at the aggregate demand equation:. Consumer spending typically equals two-thirds of GNP. As you would expect, lowering taxes raises disposable income , allowing the consumer to spend additional sums, thereby increasing GNP.
Reducing taxes thus pushes out the aggregate demand curve as consumers demand more goods and services with their higher disposable incomes. Supply-side tax cuts are aimed to stimulate capital formation. If successful, the cuts will shift both aggregate demand and aggregate supply because the price level for a supply of goods will be reduced, which often leads to an increase in demand for those goods. It's a common belief that reducing marginal tax rates would spur economic growth.
The idea is that lower tax rates will give people more after-tax income that could be used to buy more goods and services. This is a demand-side argument to support a tax reduction as an expansionary fiscal stimulus. Further, reduced tax rates could boost saving and investment, which would increase the productive capacity of the economy. However, studies have shown that this isn't necessarily true. A working paper for the National Bureau of Economic Research found that tax cuts aimed at high-income earners have less economic impact that similarly sized cuts targeted at low and moderate income tax payers.
In other words, economic growth is largely unaffected by how much tax the wealthy pay. Growth is more likely to spur if lower income earners get a tax cut. Because of the ideal of fairness, cutting taxes is never a simple task. Two distinct concepts are horizontal equity and vertical equity. Horizontal equity is the idea that all individuals should be taxed equally. An example of horizontal equity is the sales tax, where the amount paid is a percentage of the article being purchased.
Taxes are proportional. 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 a progressive tax because the fraction paid rises as income rises.
Reducing taxes becomes emotional because, in simple dollar terms, people who pay the most in taxes also benefit most. Although the percentage benefit is the same, in simple dollar terms, the Mercedes buyer benefits more. Taxes and the Poor How does the federal tax system affect low-income households? What is the difference between refundable and nonrefundable credits? Can poor families benefit from the child tax credit? Why do low-income families use tax preparers?
How does the earned income tax credit affect poor families? What are error rates for refundable credits and what causes them? How do IRS audits affect low-income families? Taxes and Retirement Saving What kinds of tax-favored retirement arrangements are there? How large are the tax expenditures for retirement saving? What are defined benefit retirement plans? What are defined contribution retirement plans? What types of nonemployer-sponsored retirement savings accounts are available?
What are Roth individual retirement accounts? Who uses individual retirement accounts? How does the availability of tax-favored retirement saving affect national saving? What is an automatic k? How might low- and middle-income households be encouraged to save? Taxes and Charitable Giving What is the tax treatment of charitable contributions? What entities are tax-exempt? Who benefits from the deduction for charitable contributions? How would various proposals affect incentives for charitable giving?
How large are individual income tax incentives for charitable giving? How did the TCJA affect incentives for charitable giving? Taxes and Health Care How much does the federal government spend on health care? Who has health insurance coverage? Which tax provisions subsidize the cost of health care? How does the tax exclusion for employer-sponsored health insurance work?
What are premium tax credits? What tax changes did the Affordable Care Act make? How do health savings accounts work? How do flexible spending accounts for health care expenses work? What are health reimbursement arrangements and how do they work? How might the tax exclusion for employer-sponsored health insurance ESI be reformed? Taxes and Homeownership What are the tax benefits of homeownership?
Do existing tax incentives increase homeownership? Taxes and Education What tax incentives exist for higher education? What tax incentives exist to help families pay for college? What tax incentives exist to help families save for education expenses? What is the tax treatment of college and university endowments? Tax Complexity Why are taxes so complicated?
What are the benefits of simpler taxes? What policy reforms could simplify the tax code? Wealth Transfer Taxes How do the estate, gift, and generation-skipping transfer taxes work?
Who pays the estate tax? How many people pay the estate tax? What is the difference between carryover basis and a step-up in basis? How could we reform the estate tax? What are the options for taxing wealth transfers? What is an inheritance tax? Payroll Taxes What are the major federal payroll taxes, and how much money do they raise? What is the unemployment insurance trust fund, and how is it financed?
What are the Social Security trust funds, and how are they financed? Are the Social Security trust funds real?
What is the Medicare trust fund, and how is it financed? Excise Taxes What are the major federal excise taxes, and how much money do they raise? What is the Highway Trust Fund, and how is it financed? Energy and Environmental Taxes What tax incentives encourage energy production from fossil fuels?
What tax incentives encourage alternatives to fossil fuels? The provisions included commitments to reduce taxes, shrink the federal government, and reform the welfare system. By , unemployment had dropped to 5. Clinton resisted the bill at first but ultimately signed it. While some economists believe that the tax cuts were better medicine for the economy, the second term for the Clinton administration had the benefit of the technology boom that produced the computer and Internet revolutions.
Many of the high-tech jobs created by that boom were lost when the Nasdaq cratered after Clinton left office, bottoming out in Oct. One interesting data point is the relative stability of tax revenue as a percentage of GDP, regardless of the existing tax policies over time.
According to the World Bank , during the period to , which encompassed both Reagan and Clinton, the tax revenue as a percentage of U. GDP hit a low of 9. This indicates that the best way to jump-start revenues is to grow the economy through stimulative tax policies. President Barack Obama consistently pushed for higher taxes on the rich to help reduce the deficit. Later, President Donald Trump got a substantial tax decrease across the board, with the bulk of the cuts benefitting upper-income taxpayers.
Nevertheless, the debate continues on whether or not higher rates actually result in more tax revenues. The problem is that changes in tax rates can't be analyzed in a static environment, although that's how politicians tend to view them. The fact is that changes in rates alter behavior and most taxpayers will do whatever it takes to minimize their tax burden. It's easy to find evidence supporting contrary positions, but there's a problem when analyzing historical data.
We'll never know what would have happened if the opposing position had been implemented during the same time frame and under the same conditions. The debate, no doubt, will continue. Federal Reserve Bank. Bureau of Labor Statistics. Yahoo Finance. Bureau Labor of Statistics. Trends From the Current Population Survey. The World Bank. For a state like Illinois, ballooning deficits and liabilities—which significantly hamper future investments in infrastructure and education—are a greater concern than a handful of potential corporate defections to Indiana.
Too often, local and state governments think they can boost their economies by offering companies generous tax incentives to move to or stay in their area. City after city promised enormous tax relief, only to watch the tech giant choose New York and Washington, D. Clearly, the company had considered other factors beyond taxes.
Somewhat ironically, criticism over generous tax breaks ultimately led Amazon to drop its plans to expand into New York City. When McGuire was policy advisor to the Minnesota government in the s, the freight railroad network Burlington Northern complained that taxes were too high and moved its global headquarters out of state.
The state set up a tax study commission to evaluate whether its tax system was at risk of driving other firms to leave the state. As part of that commission, McGuire spoke to a number of executives, including at 3M. Just create a rational, fair system that gives companies confidence and let the thing run.
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