Tax Cuts—Sweet, but are they a Sugar High?

By: Dr. Lynn Reaser

Generally, tax cuts lead to more economic activity, which is why they have been part of most stimulus programs, including those implemented by both Democrats and Republicans.  The structure of cuts will determine their impact.  Tax cuts focused on household spending will tend to have a more immediate effect, while cuts promoting saving and investment will have a longer term impact. 

 Historically, tax cuts have also been used to help spur activity in certain parts of the economy, including housing, alternative energy, research, and even car sales.  Sometimes these tax cuts just affect the timing of spending.  For example, the “cash for clunkers” program boosted car sales temporarily, with sales falling back after the tax incentives expired.

 The major constraint limiting the effectiveness of tax cuts involves the deficit.  If investors regard government finances as tenuous, they will demand higher interest rates, which could choke off any positive impact intended by the tax reductions.



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