Tax Cuts May Prove Better for Politicians Than for Economy

Debate over extending the Bush tax cuts continues on Capitol Hill. Republicans and a few democrats argue that we must extend the tax cuts to prevent harming small businesses and choking out the economy. Those arguing for the tax cuts believe this action will please the American Public and increase investment. When reviewing the Regain Deficit, we learned that increased government spending while decreasing taxes actually reduces saving, increases the interest rate, increases consumption and decreases investment. Essentially this is a supply-side remedy for a problem caused by lack of demand. President Obama instead hopes that his recent investment incentive plans will encourage businesses to invest thereby increasing demand. Republicans argue that Investment incentives coupled with a tax increase is not going to get the economy moving. We learned that when there’s an increase in taxes and government spending, we must see an equal decrease in another category of demand. When taxes are increased, disposable income is lowered, which also lowers consumption by MPC (y-deltaT). In turn, national savings increases by the amount consumption falls. As for increased government spending, we’ll see a continued decrease in investments which will force interest rates to rise. Maybe the solution is increasing taxes and decreasing government spending?