impact of a fall in corporate tax (3)

Question 1

microeconomic impact of a fall in corporate tax

Answer 1

• fall in tax -> more retained profits -> firms more likely to invest in capital (e.g. machinery, R&D, technology, etc.) -> increased productivity -> increased dynamic efficiency
• if firms expand businesses + increase production -> increased demand for labour -> higher wages
• lower prices for consumers: lower taxes = cost of production falls -> firms might pass this on

Question 2

evaluate the microeconomic impact of a fall in corporate tax

Answer 2

• if firm = oligopoly (or market structure w/ limited competition) -> less choice -> firms may exploit this and not charge consumers lower prices
• less competition -> less incentive to innovate -> less productively efficient + increased X-inefficiency
• depends on business confidence + size of the tax cut -> firms may not even invest

Question 3

macroeconomic impact of a fall in corporate tax

Answer 3

• fall in tax -> more retained profits -> increased investment (15% AD); injection into circular flow-> increased AD -> increased real GDP -> +ve multiplier effect -> businesses expand production to meet increased demand for goods + services -> increased DFL (labour = derived demand) -> reduced cyclical unemployment -> reduction in -ve output gap -> workers have income -> more consumer spending -> C up (60% AD)-> real GDP increased further -> actual eco. growth
• more reinvestment -> can increase productivity + reduce LRAC -> increased LRAS -> potential eco. growth
• lower production costs -> lower prices for consumers -> exports more price competitive -> E>I -> improved current account deficit

Question 4

evaluate the macroeconomic impact of a fall in corporate tax

Answer 4

• lack of business confidence -> firms do not invest -> no rise in AD/LRAS -> limited growth
• 15% is a small component of AD -> unlikely to have a significant impact
• depends on the size of the multiplier
• less corporate tax = less tax revenue = less spending on welfare benefits + investment into public services -> reduced SOL
• if AD does increase -> trade off -> demand pull inflation (Phillips Curve)