Essay Plans

Argue the case of cutting income tax as a means of reducing unemployment.
SYNOPSIS: The UK government cut income tax in the 1988 budget primarily to reduce unemployment but in the context of switching taxation gather from direct to indirect. The economic philosophy behind this is represented in part by the Laffer Curbe also as tax is cut, demand increases thus employment increases. POINTS: 1. There are two main areas of discussion here: a. A tax cut means that disposable income per job rises - this makes the job more attractive. Ceteris paribus, more people will be willing to supply labour at any given wage. b. As wages in effect have risen, people will want smaller increases thus the price of labour will fall. This will increase the demand for work or the supply of jobs on offer at any particular wage. Just as unions and their activities have lead workers to price themselves out of the jobs by asking for wages above the market equilibrium, so workers will price themselves into jobs by asking for lower wages (although higher take-home wages). 2. Dealing with (a): c. It is not possible to supply more labour at a particular wage. One car park attendant working 9 - 6 cannot work any more even though the disposable income has risen as the job is only for 9 hours. d. The increase in disposable income has come about without any additional work if it is via threshold increase the increase is the same for all within a wide category. The amount of the increase for those in that category is independent of the work done. e. Thus, people will have two choices : say 'Thank you for the extra income' OR have extra leisure, work less hours and stick to the same income. All work involves the opportunity cost of reduced leisure (this book was written whilst on holiday in sunny Trinidad - the cost involved the lost time on the beaches!) SOME people will therefore work less hours than before. f. Where the inverse is in the form of a tax rate cut work will not pay a higher rate per hour and thus people will be encouraged to supply more of it. This SUBSTITUTION EFFECT will mean less leisure, more work. BUT, as before, people will be now worse off for working less - the INCOME EFFECT. The size

of the effect will vary from person to person but also from tax band to tax band. Those with incomes close to the tax threshold will experience little difference in a cut in income tax and thus will work harder; those who earn a lot will receive greater benefits and will, one assumes, work less. g. Those below the threshold will, if the threshold is raised, work harder. The incentive to work above the threshold is also now greater if the basic rate is taxed. This same argument would apply to those unemployment. h. Some unemployed will only accept work as a particular wage. This wage is now more likely after tax cuts BUT greater benefit will be obtained than before if he waits for an even higher wage thus the period of unemployment may lengthen. i. Raising the tax threshold similarly makes take-home pay higher and increases the incentive for the unemployed to find work. j. If tax cuts increase spending this will increase demand which will lead to an increase in demand for labour thus reducing unemployment. As with so much of economic thought, it depends on other factors, eg. if tax cuts raise demand too quickly for the supply of labour to react there will be inflation which itself may cause unemployment. Tax cuts will lead to less government spending (this may be developed and contradicted by the Laffer Curve). Thus there will be an employment shortfall elsewhere. If tax cuts become central to political survival, even if there is inflation, taxes will stay low and interest rates for example will be raised. This is turn discourages investment, creates unemployment etc, etc. k. Point (h) needs to be developed and supported with current figures from the UK economy as tax cuts have in particular been used in this economy as part of an unemployment-reducing policy.

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