FISCAL POLICY

Sample Answer

Part 1: Pros and Cons of Tax Cuts as a Fiscal Policy

Tax cuts represent a common expansionary fiscal policy where the government reduces the tax burden on individuals and/or corporations. The intention is to stimulate economic activity by increasing disposable income for consumers and encouraging investment by businesses.

Pros of Tax Cuts:

Stimulates Consumption and Investment: Lower income taxes leave individuals with more disposable income, potentially leading to increased consumption. For businesses, lower corporate taxes or investment incentives can encourage greater capital expenditure, research and development, and hiring. This directly boosts aggregate demand.

Supply-Side Effects: This is where supply-side economics comes into play significantly. Supply-siders argue that lower marginal tax rates incentivize individuals to work more, save more, and invest more, as they keep a larger percentage of their earnings. For businesses, lower taxes on profits can encourage them to produce more, take greater risks, and innovate. The theory posits that these incentives shift the aggregate supply curve to the right, leading to increased long-term economic growth without necessarily causing inflation. The argument is that by making it more profitable to produce, the supply side of the