The debate that tax cuts may increase disposable income or reduce burden and boost economic growth is controversial and unsettled. Some believe increasing tax burden on corporate inversely affect the social welfare of the economy while others argue that they enhance growth.
Those who are not satisfied with the tax-cut arguments believe that the revenue earned from increased taxes can be directly invested in developmental activities. This essay discusses some of the arguments for and against reduction of corporate taxes and the way it may affect the social welfare of the economy.
One of the arguments presented in support of tax-cut is that taxes have an overbearing burden on firms. The tax burden argument suggests that taxes already are overbearing burden on the organizations that pay them. These taxes are believed to directly affect the business revenue and/or increase the cost to the companies. More directly, taxes have a negative effect on the profit of the businesses.
When profits are lowered, it reduces the capability of firms to expand their business, employ new people, or invest in newer avenues. Further, the supporters of this argument believe that as different states different tax burden, the businesses tend to move to states that keep the tax burden lower. In other words, the supporters of the tax-burden argument believe that with higher tax rates, the profit of firms are reduced therefore, reducing the capacity of companies to expand business.
However, the tax-burden argument has certain flaws. Critics believe that state and local taxes on businesses have a relatively small burden operating costs and therefore have little effect on firm’s profit. These after-tax profits are also lower as these figures do not capture the real tax cut as the “tax incidence” (i.e. people who actually pays the taxes) are not considered while making these accounting calculations.
Further, after-tax profits of the firms do not vary significantly after the state taxes are applied to their profits. This is so because the federal taxes have a leveling effect on the state and local taxes deductions. Further, taxes provide support to the public, which in a way is aimed to reduce costs of businesses. Therefore, taxes are not essentially burden to the firms.
Therefore, understanding the pros and cons of the tax-cut arguments shows that state and local taxes have a small burden on the businesses and are unlikely to affect their operating costs.
Another prevalent argument for tax-cut is supply side argument. It is argued that tax cuts allow firms to increase their profit and therefore their savings, which is directly invested towards economic growth. Individual tax cuts also enhance the propensity of people to save more and therefore increases their desire to earn more. In case of businesses, applying similar argument, it can be intuitively deduced that lower taxes would increase profit, and therefore, higher liquidity to invest in different areas of business.
Some of the problems with the supply side argument are that research demonstrates that the positive effect of tax cut as an incentive to worker more is grossly overestimated. The second problem with the argument is that tax cuts may actually act as a negative impetus to work as people will have more disposable income with lower taxes and therefore may feel less need to work.
Evidence shows that as after-tax income has increased over the years, people have chosen to retire earlier in their work-life-span, which actually shows that tax-cuts may lead to the desire to work less. Further, supply-side tax cuts may increase income inequality between those who work hard and those who do not. So the critics argue that as tax is not related to work effort but directly to income, income inequality may not induce greater work.
On the other hand, greater inequality of income may increase the amount of the dissolution among those who fail earn more. Further, even if there is a greater savings among individuals of a state due to tax-cut, overall it will have very little effect on differential savings in comparison to other states, and therefore, lead to very little investments. The supply side tax-cut arguments do not fully comprehend the demand side effect of tax cuts that are more likely to reduce economic growth.
The demand side argument for tax cuts is that economic growth and businesses grow as people spend more or have higher demand. Hence, with tax cuts, which would lead to greater disposable income, individuals can spend more, therefore increasing demand. Therefore, this is likely to increase jobs.
This demand side argument has two weaknesses. First, state tax cuts do not have any significant effect on the spending impulse of individuals, therefore, not affecting demand. However, such tax cuts actually reduces local government revenue, and therefore, within state public spending. The second weakness is that demand side theory supports tax increase by local authorities.
Proponents of tax-cuts believe that a reduction in local taxes would positively affect the business climate as it shows that the state being supporting of business. however, the weaknesses of this argument is that businesses are influenced by the mere concept of “perception” of a state being lenient. A firm’s decision to do business in a state is based on many more factors than just tax burden. The second reason against this argument is that it may negatively influence the business climate.
Lower taxes, it is argued, would make the local governments more competitive in attracting businesses for it is assumed that states engage in economic competition amongst each other. However, certain weaknesses against this argument are that local governments must provide tax cuts and incentives to lure businesses and retain them in the state.
However, such tax cuts may send out a wrong signal and give out a perception that the local body has difficulty in retaining businesses. State taxes are meant as revenue for local bodies to utilize it in local developmental activities. A reduction in the taxes would imply reduced income of the local bodies and directly affect the developmental activities.
In order to enhance developmental activities, it is more advisable to redirect the revenue earned of taxes towards strengthening child education system. This would help many poor and underprivileged children would otherwise receive no education and proper way of life. Child development programs actually help in enhancing the intellectual and educational capability of the children.
Further, such programs would also help in higher graduation rates from schools, leading to higher employability and consequently, earning. A better life earned through a better education would eventually lead to better health among the children. Higher incomes imply less welfare dependency, therefore reducing state burden, and lower crime rates. Eventually this would lead to greater government savings.