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Explain whether or not a tax cut will unambiguously lower income-tax revenue.

Explain whether or not a tax cut will unambiguously lower income-tax revenue.

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Answer #1

A tax cut will not unambiguously lower income -tax revenue.

Because. It depends on how the quantity of labor supplied responds to the increase in the after-tax wage rate. If the income effect dominates, the quantity of labor supplied falls and so will tax revenue. If the substitution effect dominates, the quantity of labor supplied increases, and income-tax revenue could increase. This is a function of whether the after tax wage was low already because the tax rate was relatively high.

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