Chapter 17, Problem 15AA

To determine

To evaluate the best way to stimulate the economy by supply side economists.

Explanation of Solution

Supply-siders assert that the macroeconomy is influenced by three main aspects:

1. Labor supply, which is calculated by salaries and incomes following abolition of taxes.
2. Saving, which is calculated by the rate of return to invest after tax.
3. Business investment which is measured by the rate of return on capital investment after tax.

The idea is that personal income tax cuts trigger a rise in labor supply as people increase their work effort and working hours. Tax cuts on savings are helping people money. For this cause, supply-siders are supporting decreases in tax rates on capital gains. Cutting taxes on corporate income is causing business expenditure to increase. Improved supply of labor, savings and investment contribute to further net production and increased economic growth.

A few supply siders favor a flat tax. A flat tax is proportional, so all companies and individuals would be paying the same tax rate. Theoretically, a truly proportional tax should improve economic productivity but it would make the tax system less progressive. This exemplifies the repeated economic trade-off between effectiveness and equity. Some experts see a flat tax as a Trojan horse intended to slash tax rates and overall tax revenues. That is why tax reforms are often intended to be neutral.

Economics Concept Introduction

Introduction: In the 1980s, a new form of neoclassical economics became common, which was supply-side economics. Supply siders assume that after-tax exposure to that sector were driven by economic growth. Thus, people are drawn to well-paying jobs and companies are drawn to high-profit sectors. In addition, tax cuts are increasing economic growth.