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ECON 0110 Lecture Notes - Lecture 21: Arthur Laffer, Laffer Curve, Aggregate Supply

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brownduck476
13 Feb 2015
School
Pitt
Department
Economics
Course
ECON 0110
Professor
K E N K E L

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Document Summary

Refers to government policies that focus on stimulating the economy by boosting the aggregate supply of goods and services rather than by boosting the aggregate demand for goods and services. It recommended tax cuts for businesses which would boost potential profits and encourage businesses to increase output. This would boost the rate of return on an hour of work and would encourage laborers to work more. If individual tax rates are cut, the disposable incomes of workers increase. With higher incomes, some workers might choose to work less and enjoy leisure time. As a result, the effects of the corporate tax cut will trickle down and workers will benefit. A graph showing total tax revenue as a function of the tax rate. Named after the economist arthur laffer who advised president reagan. If tax rate = 0%, tax revenue = sh. If tax rate = 100%, tax revenue = sh (because no one would work if the government took.

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Related Questions

1) Modern mainstream macroeconomists agree with the monetarists that:

a) the Fed should increase the money supply at a fixed annual rate.

b) velocity is highly stable.

c) fiscal policy is largely ineffective.

d) "money matters" in the macroeconomy.

2) The velocity of money is the:

a) relationship between the money supply and the price level.

b) number of times per year the average dollar is spent on final goods and services.

c) relationship between asset and transactions demands for money.

d) price level divided by aggregate supply.

3) When most consumers and firms reduce spending only because they expect other consumers and firms to reduce spending, and a recession results:

a self-correction has occurred.

an adverse aggregate supply shock has occurred.

a coordination failure has occurred.

a real-business-downturn has occurred.

4) (Last Word) Suppose that real GDP falls to 2 percent below potential GDP. Then, according to the Taylor rule, the Fed should reduce the Federal funds, relative to the current rate of inflation, by:

1/2 percentage point.

1 percentage point.

2 percentage points.

4 percentage points.

5) Critics of supply-side economics:

argue that a tax cut will increase aggregate supply by more than it increases aggregate demand.

contend that the relationship between tax rates and economic incentives is small and of uncertain direction.

believe that a decline in tax rates will increase tax revenues.

point out that tax cuts enable households to substitute work for leisure.

1. The primary tool used by supply-side economists to eliminate macroeconomic problems is

A. the discount rate.

B. corporate tax rates.

C. government spending.

D. open market operations.

E. the reserve requirement.

2. When the Federal Reserve System buys government securities on the open market,

A. the money supply will decrease.

B. excess reserves at commercial banks will decrease.

C. excess reserves at commercial banks will increase.

D. interest rates will increase

3. One of the advantages of automatic stabilizers over discretionary fiscal policy is that automatic stabilizers

A. has a greater multiplier effect than discretionary policy.

B. is not subject to the time lag problems of discretionary policy.

C. does not produce a deficit during recessions as a discretionary policy does.

D. makes the actual budget a better reflection of the condition of the economy than the full-employment budget.

4. "I have promised to do everything in my power to reduce the federal deficit. That means reducing federal expenditures and, if necessary, increasing taxes. Under present conditions of full employment and steady prices, we can afford to bear the burden of this debt (i.e., pay off the debt) now instead of passing it on to our children and grandchildren."

If the policies of the Senator quoted above were adopted, what effects would be expected while these policies were being implemented?

A. higher inflation

B. increases imports

C. higher rates of economic growth

D. increased unemployment and idle capacity

5. An inflationary gap can be reduced or completely closed by

A. decreasing taxes while leaving government spending on goods and services unchanged.

B. decreasing government spending on goods and services while leaving taxes unchanged.

C. increasing government spending on goods and services while leaving taxes unchanged.

D. increasing both government spending on goods and services and taxes by the same amount.

6. Compared to fiscal policy, an advantage of monetary policy is its

A. greater flexibility.

B. highly selective impact on segments of the economy.

C. ability to eliminate cost-push inflation.

D. need for approval by Congress.

E. need for approval by the President.

7. An increase in government spending on goods and services which causes a budget deficit to exist

A. is always inflationary.

B. is more inflationary than equal increases in private spending.

C. is usually not inflationary when the economy is operating at its full-employment level of output.

D. will not necessarily cause serious inflation as long as there are unemployed resources in the economy.

8. Some analysts believe the tax cuts enacted during the President H.W. Bush administration represented a supply-side economic policy rather than a Keynesian fiscal policy because

A. the tax cuts were accompanied by decreases in interest rates.

B. the tax cuts were accompanied by increases in government spending.

C. the tax cuts were primarily aimed at upper-income groups and businesses.

D. the tax cuts were primarily aimed at middle income and lower-income groups.

9. When the federal government is stabilizing the economy by increasing taxes, monetary authorities should

A. take actions to decrease interest rates.

B. increase the supply of money.

C. buy government securities in the open market.

D. follow an expansionary money policy.

E. follow a contractionary money policy.

10. Suppose a commercial bank has demand deposits (checking accounts) of $400,000, actual reserves of $170,000, and a reserve requirement of 20%. This single commercial bank can lend a maximum of ______ and the banking system can increase loans by a maximum of ______

A. $90,000 and $450,000.
B. $90,000 and $360,000.
C. $90,000 and $170,000.
D. $170,000 and $450,000.

E. both can lend an unlimited amount.

11. Which of the following would most likely result if the federal government increased its spending without changing tax revenues during a period of full employment?

A. inflation

B. a recession

C. lower interest rates

D. a larger net exports deficit

12. Fiscal policy that emphasizes cutting taxes as a means of improving incentives to work, and invest would be characterized in aggregate demand - aggregate supply framework primarily a shift

A. left in the aggregate demand curve.

B. left in the aggregate supply curve.

C. right in the aggregate supply curve.

D. no shift in either the aggregate demand curve or the aggregate supply curve.

13. Which of the following will result in the greatest increase in aggregate expenditures/demand?

A. A $100 decrease in personal income taxes

B. A $100 increase in personal income taxes

C. A $100 increase in government expenditures

D. A $100 increase in government expenditures which is accompanied by a $100 increase in personal income taxes

E. Both A and C will have the same effect on aggregate expenditures

14. You are given the following information about aggregate demand for an economy: (1)consumption = $600 billion; (2) investment = $50 billion; (3) government purchases = $100 billion; and (4) net export = $20 billion. If the full-employment level of GDP for this economy is $720 billion, then what combination of actions would be most consistent to achieve full employment and stable prices?

A. an increase in government spending and taxes

B. decrease government spending and taxes

C. decrease government spending and increase taxes

D. increase government spending and decrease taxes

15. Advocates of fiscal policy agree that discretionary fiscal policy will stabilize the business cycle most when the federal government

A. continuously incurs budget deficits.

B. continuously runs budget surpluses.

C. balances its budget every year.

D. incurs budget deficits during recessions and budget surpluses during demand-pull inflations.

E. incurs budget surpluses during recessions and budget deficits during demand-pull inflations.

16. Discretionary fiscal policy that increases the government budget deficit has the same effect on equilibrium as

A. an increase in personal saving.

B. an increase in business investment.

C. a decrease in government spending.

D. a decrease in personal consumption expenditures

 
After reading the article, post substantive comments on the economic impact of the Tax Cuts and Jobs Act of 2017.
 
THE ECONOMIC IMPACT OF THE TRUMP TAX CUTS
April 25, 2018
The Economic Impact of the Trump Tax Cuts
By Hilary Schmidt, International Banker
 
On December 22, US President Donald Trump signed into law the Tax Cuts and Jobs Act of 2017. The legislation is one of the most radical changes to fiscal policy the United States has undertaken in decades, with sweeping amendments implemented across the entire breadth of the tax code. Indeed, in his State of the Union Address, Trump called it the biggest tax cuts and reforms in American history. As such, its impact is likely to be felt throughout the economy for quite some time to come.
 
It is arguably the cut in a corporate tax that forms the centrepiece of this new legislation, with the rate being cut from 35 to 21 per cent. That puts the new rate broadly in line with the worldwide average, which as measured by the Tax Foundation across 202 jurisdictions currently stands at 22.96 per cent or 29.41 per cent when weighted by gross domestic product (GDP). Corporations will also stop having to pay corporate tax on any income earned from foreign operations, while such money that is brought back home will be taxed between 8 and 15.5 per cent, significantly lower than the 35-per cent tax they are currently paying.
 
Republicans believe such substantial cuts will spur a massive influx of business investment that will eventually lead to higher average wages for Americans. For example, Texas Congressman Mike Conaway stated, It's in all of our best interest to have these tax cuts for corporations so that they will have more money to invest in their business and pay their workers. But much of the research conducted thus far suggests otherwise; the Center on Budget and Policy Priorities, for instance, recently concluded that workers would receive a maximum of only a quarter of the benefits from tax cuts; and even then, it is most likely to be the higher earners that would be the biggest beneficiaries.
 
Another piece of evidence to which analysts are pointing is data from S&P Dow Jones Indices, which shows that non-financial companies in the S&P 500 are already flush with cash at the moment, having between them an estimated $1.63 trillion. And despite this vast sum of cash, an investment boom has not transpired. Indeed, some top companies have made it explicitly clear that any tax relief they receive from the reforms will be primarily used to increase dividends and buy back stock to boost share prices. Amgen CEO Robert Bradway, for example, said We've been actively returning capital in the form of growing dividend and buyback, and expect us to continue that. And in terms of what businesses planned to do with any profit returned from abroad, a Bank of America Merrill Lynch survey of more than 300 CEOs found that paying down debt and stock buybacks were by far and away from the biggest priorities for businesses.
 
The other major pillar of the reform is the cuts that have been enacted for individual income earners, with middle-class taxpayers earning between $19,050 and $77,400 per year receiving a cut in tax from 15 to 12 per cent. Higher-bracket earners, meanwhile, will see their tax rates go from 25 to 22 percent (for incomes between $77,400 and $165,000); 33 to 24 percent ($165,000 to $315,000); and 39.6 to 35 percent ($400,000 to $600,000). And as far as analysis from the Tax Center is concerned, after-tax income will increase by an average of 2.2 per cent across all groups. However, all of this changes after a few years, due to official budget rules that limit the cost of the bill to $1.5 trillion in total which therefore means that to make the corporate tax cuts permanent, the individual tax relief will expire by 2025. As such, a tax increase will likely result by 2027, which, according to projections by the Tax Policy Center, will impact 53 per cent of Americans.
 
Whether the overall impact will be a net positive or negative for the US economy remains to be seen at this stage, therefore. While most analysis produced to date agrees that economic growth will receive a boost in the short-term, the predictions that have so far come in have been decidedly more mixed and less sure for longer time horizons. The non-partisan Joint Committee on Taxation of the US Congress expects the gross domestic product to be 0.8 per cent higher on average each year during the next 10 years than baseline forecasts, thanks mainly to an expected increase in labour supply and business investment. According to the independent non-profit research organisation the Tax Foundation, meanwhile, the plan will primarily reduce marginal tax rates and the cost of capital. In turn, this will lead to a 1.7-per cent rise in GDP over the long-term, a 1.5-per cent increase in wages and a further 339,000 full-time equivalent jobs. This year, moreover, will see GDP growth being posted at 2.45 per cent, compared to baseline growth of 2.01 per cent.
 
But most analysts see the economic benefits tapering off much sooner than the 10 years asserted by the Joint Committee on Taxation. Goldman Sachs, for example, believes the tax cuts will only slightly boost growth in the short-term before fading quickly. Alec Phillips and Blake Taylor, analysts on Goldman's US economic-analysis team, stated in December that the bank's estimate of the growth effects of the legislation in 2018 and 2019 would be 0.3 per cent per year, before dropping off. Indeed, Phillips and Taylor warn that the legislation may end up damaging the economy in the long run: We note that the effect in 2020 and beyond looks minimal and could be slightly negative.
 
Some also point to the fact that the cuts will drastically deepen the national debt, with Maya MacGuineas of the Committee for a Responsible Federal Budget estimating an additional $1.5 trillion will be added to the $10 trillion already forecast for the next decade. As she explained, Instead of trickling down economic growth, the House plan will unleash a tidal wave of debt that will ultimately slow wage growth and hurt the economy. She seems to have a point the debt today is 77 per cent of GDP, much higher than the 31 per cent in place when the 2001 Bush tax cuts were passed, and the highest it has ever been save for the period just after World War II. What's more, given that interest rates could well rise faster than expected as a result of the likely ballooning of the debt, it may well dampen the expected boost to business-capital expenditure, consumer spending and wage growth.
 
Indeed, the arbiter of monetary policy itself, the Federal Reserve, has indicated that it remains somewhat unsure of the overall impact of the tax cuts. According to the released minutes of the central bank's December meeting, growth will only modestly be boosted, with members of the Fed's board and presidents of its member regional banks saying they expect real GDP growth of just 2.2-2.6 per cent and a median expectation of 2.5 per cent growth for this year. The comparatively tempered projections are reflective of the debate within the Fed over just how much of a boost business investment and consumer spending will receive from the tax cuts.
 
According to the minutes, Many participants judged that the proposed changes in business taxes, if enacted, would likely provide a modest boost to capital spending, although the magnitude of the effects was uncertain. While they are highly likely to have a positive effect on economic growth, the Fed also warned that much of the extra cash that is generated is more likely to be utilised for mergers and acquisitions or debt reduction and stock buybacks. Moreover, the boost to consumer spending may have already occurred in part on the back of realised future tax-cut expectations.
 
Ultimately, it may be too soon to make any firm conclusions about how impactful the tax cuts will eventually be; but given that the US economy is already experiencing strong economic growth, and given that virtually all the signs point to an economy operating at full employment and therefore, at full capacity such sweeping reforms that have been at least partly designed as an economic stimulus could well be dangerous. The impact on inflation and debt may well force the Fed to hike rates more than the three times that back in December it had projected for 2018. Time will tell.