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What are the major arguments for and against cutting taxes?

by Expert Dr. Didion | 26 Apr 2017

A tax refers to a monetary charge or levy that is imposed to an individual or legal entity by a government or state in order for it to run the affairs smoothly. Taxes may either be direct or indirect and could be paid in money or labor equivalent. Taxes are enforced contribution in line with legislative authority.

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Tax policies are commonly used by a state to create jobs and to bring about economic growth. Taxes are important part of costs in any firm and any improvement in production depends on the level of taxes and the tax incentives offered. However the tax may have insignificant effect on the profit of the firm in that a firm is faced with more and significant costs other than the tax. Tax becomes insignificant when is compared to location specific costs and other varied location factors like qualified workers, proximity to customers and quality public services because they can be more crucial than taxes. The presence of these crucial location factors depends almost entirely on each state and locality’s commitment to public investment and their ability to pay them Robert (2004).

Public investment can have major positive effect in that it helps in lowering the costs of production of a firm. For tax cuts and incentives to have positive effects to a business it depends on how the firm will react to the above location factors. Taxes if increased are believed to stimulate economic development and employment growth that is, when the tax is used to expand the quantity and quality of public services.
Five major arguments for tax cuts and tax incentives offered at state and local level and believed to bring about economic development and employment growth are; the tax burden, the supply-side effects, the business-climate impacts and the competitiveness implications of taxation.

The Tax Burden Argument

According to this argument state and local business taxes are big burdens to the firms that pay them. The taxes lower the revenues and greatly increase the costs of operation of the firms. The resulting low profits cannot be reinvested and thus no additional hiring of workers. State and local business tax cuts and incentives encourages firms to save their revenues and to reduce the cost of operating business thus increasing profits. Higher profits brought about by business tax cuts and incentives would encourage firms to reinvest and expand. It will also stimulate investors to relocate to other states that offer business incentives. The result will be massive creation of employment opportunities Robert (2004).

However there are three basic flaws in the tax burden argument;

  • The state and local taxes are seen to be relatively small burden on businesses. The taxes don’t reduce the profit of the business significantly.
  • The after tax rates of profit don’t vary much within industries by state.
  • The taxes are not seen as burden but as way by the state to get financial support to give public services that would have end result of reducing business costs.

The Supply-Side Argument

According to this argument, tax cuts on businesses and individuals give incentives for work and lead to increased savings and investment thus stimulating economic activities. Tax cuts give individuals moral to work long hours and harder and would enable them to save what they earn. Prospective investors to start new businesses may then use the savings of the individuals. Tax cuts on businesses would give investment incentives by increasing profitability of an investment. Thus funds would be accessible for reinvestment Robert (2004).

  • However this argument cannot be applied at state and local level because of the following weaknesses;
  • Cohorts of supply side economics overstate the merit effects of tax cuts on savings and work effort.
  • The tax cuts may not bring about low interest rates and increased productive investment because the individuals savings from the tax cuts are insignificant.
  • The demand side effects, which are overlooked by the supply side, may bring about reduced economic growth and job creation.

The Demand-Side Argument

According to this argument, tax cuts for individuals and businesses stimulate economic growth from the aspect of spending. The tax cuts increase the income of individuals and businesses. The partly increased income can be saved while the remaining part can be used to buy goods and services. Higher spending would increase the sales volume and would stimulate firms to produce more. Hence firms with pressure to produce more will be forced to hire more workers.

Although tax cuts can lead to economic growth and job creation, it holds true if it will lead to increase in spending. Conversely it will lead to low economic growth and loss of jobs if the tax cuts reduces the levels of spending Robert (2004).

The state and local tax cuts cause businesses and individuals to spend more. It will cause government revenue to reduce, limiting the government spending in public projects.

Demand side theory should not be applied because it can be used to defend increases in state and local taxes. State and local tax increment will push the state and local government to spend more and decrease the individual and businesses spending

The Business-Climate Argument

This argues that a state can promote economic development through creating a conducive business climate. Conducive business environment encompasses factors like infrastructure, tax and fiscal measures, indicators of area’s reputation, etc. The supporters of this theory argue that lower taxes and incentives improve the business climate and vice versa. It is believed that lower taxes and additional business incentives are important for economic growth and development because they give an impression that the state is supporting business.

However the business climate argument has the following weaknesses;

The business decision makers are hard to be persuaded by opinions. They make decisions based on the facts of business costs and benefits. Firms that are operating along opinions are less adjusted to the specifics about costs and benefits and are more likely to fail because they will be unable to compete in the tough market. Hence it will be suicidal for the state and local government to give tax breaks in order to encourage businesses development Robert (2004).

The presence and scope of business tax incentives may disadvantageously influence the image of a state’s business climate. It can weaken vital factors that bring about setting of business environment for business setting include efficiency and comprehensiveness of its public services which can be badly damaged by tax incentives.

The Competitiveness Argument

It is argued that it is important for the state to be involved in the competition. Tax incentives make firms to shift or stay in a given state. Thus states that do not provide tax cuts and incentives will lose businesses to those that offer. This will retard the development of a given sate at the expense of other states that will develop economically, providing employment to locals. Therefore a state will be forced to provide moderate incentives so as to survive in the competitive battle Robert (2004).

This theory however has flaws in that tax cuts and incentives are insignificant to the business and that tax cuts and incentives are not efficient use of state and local finance because the money lost by government in the form of tax revenues is more than what the firms gain as additional income.

Reference

  • Robert, Lynch. Rethinking Growth Strategies: How State and Local Taxes and Services Affect Economic Development. New York: Economic Policy Institute, 2004.
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