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How Can Tax Cuts Help Revive the Economy?

Essay by   •  January 11, 2012  •  Research Paper  •  1,006 Words (5 Pages)  •  1,751 Views

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How can tax cuts help revive the economy?

It is no secret that America's economy is in a bad way. People are losing their jobs, home foreclosures are up and most economic indicators are heading south. Many believe that in order to remedy this problem, Congress needs to propose more tax cuts to help revive the economy. Cutting taxes by federal, state and local governments will always stimulate the economy in any economic environment; however, cutting taxes is more prominent during a downturn, recession and or depression in the economy. Taxes, in general are major factors that can affect the economy, whether they are being increased or cut. Tax cuts according to (Wordnet, n.d.) are the act of reducing taxation. The main purpose of reducing taxes is to help improve the economy by boosting consumer spending. This is one major way that tax cuts help revive the economy because lowering and cutting taxes raises disposable income, allowing the consumer to spend additional monies. This money goes back into the economy and creates The Circular Flow of Economic Activity. The flow of payments in an economy is a circular flow. Individuals--people living in households--work for businesses, rent their property (or their capital) to businesses, and manage and own the businesses. All these activities generate incomes--flows of payments from businesses to households. Households then spend their incomes--on consumption goods, in taxes paid to governments (that then spend the money on goods and services), and on assets like stock certificates and bank CDs that flow through the financial sector and are then used to buy investment and other goods (Slavin, 2009, p.54-55). Reducing taxes pushes out the aggregate demand curve as consumers demand more goods and services with their higher incomes. (Slavin, 2009) defines aggregate demand as the "total value of real GDP that all sectors of the economy are willing to purchase at various price levels" (p.255)

Fiscal policy, a policy by the government that involves the collection and spending of revenue;"tax and spend" policy. The fiscal policy refers to efforts by the government to stimulate the economy directly, through spending. By levying taxes the government receives revenue. Taxes come in many varieties and serve different purposes, but the key concept is to transfer assets from people to the government and vice versa. When the government uses fiscal policy to increase the amount of money available to the consumers, this is called expansionary fiscal policy (Tamny, 2009). Examples of this include, lowering taxes and or raising government spending. Expansionary fiscal policy increases the output and national income. The most immediate effect of fiscal policy is to change the aggregate demand for goods and services. Fiscal policy is an important tool for managing the economy because of its ability to affect the total amount of output produced (GDP).

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