Explain why it makes a difference if consumers consider a tax cut temporary rather than permanent. What does this explanation tell us about the importance of government credibility? Put this in the context of the 2008 and 2009 tax cuts favored by President Bush and President Obama


Consumers tend to base their spending decisions on their expectations of long-run income. Short-term or one-time-only income changes have little effect on consumer behavior. If tax cuts are perceived as only temporary, then consumers will use less of the additional disposable income for spending on goods and services and may use a major portion of the temporary income increase for saving. Tax cuts that are perceived as permanent will change consumers' expectations regarding their future income more significantly. This change in expected future income will make consumers feel more comfortable about increasing their current spending. If government policy makers wish to increase aggregate demand by cutting taxes and they hope the tax cut will significantly increase consumer spending, then the public will have to believe that the government pledge to leave the tax cut in place is honest. If the public mistrusts the government and believes a current tax cut may soon be cancelled or reversed, then consumers may not change their spending habits in any significant way. This mistrust will render tax policy ineffective and remove a powerful tool from those available to a government. In 2008 and 2009, taxpayers concluded that the tax cuts were only temporary and not permanent. Because they felt the tax cuts were only temporary, they did not have the stimulative effect on aggregate demand that the administrations were hoping for.

Economics

You might also like to view...

Starting from long-run equilibrium, a large increase in government purchases will result in a(n) ________ gap in the short-run and ________ inflation and ________ output in the long-run.

A. expansionary; higher; potential B. recessionary; higher; potential C. recessionary; lower; lower D. expansionary; higher; higher

Economics

For a perfectly competitive firm, at the profit-maximizing output average revenue equals marginal cost

Indicate whether the statement is true or false

Economics

A major problem with the implementation of an annually balanced budget is that it: a. allows the national debt to burgeon with chronic deficits

b. relies upon government officials to budget for surpluses during economic booms in order to cover deficits during recessions. c. requires annual revenues to match with outlays even during times of war, when there is a sudden increase in military expenditures. d. magnifies the fluctuations in the business cycle. e. dampens swings in the business cycle.

Economics

A decrease in the price of the output produced by labor will:

A. decrease the supply of labor. B. increase the demand for labor. C. decrease the demand for labor. D. increase the supply of labor.

Economics