Tax reduction vs. Inflation
Common wisdom says that lowering taxes helps people financially because it puts more money in their pocket. This is true, at least in the beginning. But the question is, if everyone started keeping more of their income due to a large tax cut across all income levels, would prices eventually rise to offset this “gain?” I know people are full of opinions on this but I’m really after some hardcore data on the topic. Thanks so much.
Permalink Submitted by Alan Spross on Tue, 2008-02-19 18:21
That’s a very tough request, because there are so many exceptions to any conclusion. There is no doubt that a tax reduction stimulates the economy and that a stimulated economy is likely inflationary in the short run. However, the situation gets much more complex over a longer time frame because of the influence of budget deficits if spending is not reduced to match tax receipts. Deficits lead to higher interest rates and inflation also leads to fed rate increases after the short term economic problems are brought under control. Therefore, you have a very different cumulative effect in the long term than in the short term, and there is no uniform template for a standard time frame to measure. It seems that action is always predicated on the short term present day situation regardless of long term consequences, but eventually those long term consequences tend to manifest themselves in the short term as well.
Behind the on going political debate is the question of whether the private sector gets more efficient results with it’s spending than government does, and tax rates determine which sector will have the funds to spend. Government tends to spend more than the private sector also because entitlements are more permanent than a corporation business plan. Unfortunately, neither sector is immune from bone head decisions.