To Cut or Not to Cut Is Replaced by How Much
Subject Tax cut
Topic Fiscal Policy
Key Words Tax Cut, Recession, Economic Growth, Interest Rates
News Story

Although George W. Bush had made a $1.6 trillion tax cut one of the centerpieces of his platform, many were skeptical of the need for this measure. Others believed that a tax cut of that magnitude would stimulate an economy that the Federal Reserve is trying to dampen. Politically, support for Bush's tax cut was split according to party lines. But the slowing economy has changed both individual and political opinion and a compromise between Democrats and Republicans regarding a tax cut seems more likely.

President Bush is planning to introduce his tax cut proposal in the coming weeks. Democratic leaders in both the House and Senate say they are open to the idea of a larger tax cut than that proposed by Vice-President Gore during the presidential campaign, but are still opposed to the Bush proposal because it is too large. Some Democrats argue that the declining economy will result in decreased tax revenues and a decreased budget surplus. In such an environment a large tax cut is risky. Others argue over the structure of Bush's proposal. Because the Bush proposal favors the wealthy, tax cuts will increase savings rather than spending, and therefore not provide the desired stimulus to the economy.

Republicans in Congress may push for changes in the Bush proposal. Instead of one large tax cut, some Republicans favor a series of smaller and popular proposals like eliminating the marriage tax penalty and the estate tax.

Congressional leaders need to strike a balance between tax cuts, debt reduction and new spending. A compromise will likely result in a tax cut measure that is more than the Democrats want and less than what the Republicans are seeking.

(Updated February 1, 2001)

1. How do tax collections vary over the business cycle? Is the worry that the declining economy will reduce the government surplus justified?
2. What affect does a decrease in taxes have on the economy? Show using an aggregate demand/aggregate supply diagram the impact of a tax cut on equilibrium real GDP and the price level.
3. Some argue that the budget surplus should be devoted to debt reduction rather than tax cuts. They believe that a reduction in the U.S. debt will lead to lower interest rates. On your diagram show the impact of reduced interest rates on real GDP and the price level.
Source Juliet Eilperin, "Growing Support for Cutting Taxes Signals a Political Shift," The Washington Post, January 21, 2001.

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