Question

When a tax cut occurs and government spending is not cut at the same time, many not trained in

economics might think there is no cost. Present a “composition of output” analysis for a tax cut.

In examining your results, identify a benefit of a tax cut but also identify a cost. Explain WHY the

benefit you identify is a benefit. Similarly, explain WHY the cost you identify is a cost.

Answer 1

Benefit of a tax cut is that it increases disposable income. So, consumers will have more money to spend on consumption. This tax cuts is proposed when the economy is weak. Tax cuts stimulate consumption of poor and middle class people. But for rich class, a tax cut might not increase Consumption. Clearly, increase in consumption as a result of tax cut is beneficial for an economy's growth at current period.

However the cost side of tax cut is, as government spending is not cut Therefore a tax cut wil increase government budget deficit. To finance the deficit, government will borrow funds from outside and it will increase government debt. Debt is always a cost for an economy as it will affect income of our future generations. To finance debt, government will increase tax rate in future, people's disposable income in future generation will decrease and they will be poorer.