A tax cut refers to the reduction in taxes. In order to analyze how tax cuts help in the revival of the economy, it is important to evaluate the immediate effects of tax cuts, which is a decline in the total government revenue an incline in income for the taxpayer. In the long-term, the continued reduction in government revenue is subject to mitigation depending on the response of the taxpayers. In addition, tax cuts provide serves as an incentive for people and large corporations to undertake investments, which in turn may excite economic activity of a country (Baumol & Blinder, 2008).
A general theory is that tax cuts can generate extra taxable income, resulting to higher revenue compared to the collection of tax at higher rates. The long-term macroeconomic effects of tax cuts are impulsive; this is because it depends on the various ways that the taxpayers spend the extra revenue, and how the government copes with reduced levels of revenue (Larson, 2003).
There are two perspectives to view the role of tax cuts in reviving the economy; they are the Keynesian economic theory and the supply-side view. According to the Keynesian view, as the revenue grows, there will be an increase in the tax revenue and the incentive to increase earnings (Larson, 2003). This implies that a reduction in taxes from high tax rates translates to a higher economic stimulation than if tax rates reduced by the same amount from lower tax rates.
The basic argument is that as the government reduces the tax rates, there will be more money for people to spend, implying that there will be an incline in the aggregate demand, which in turn results to an increase in the Gross Domestic Product (Baumol & Blinder, 2008). This approach is an effective strategy in reviving the economy. According to the supply-side perspective, lower tax rates serve to fuel aggregate supply. The reasoning here is that if people save more of their income, they tend to work more, and companies can use this opportunity to produce more. This serves to increase the aggregate supply.
It is arguably evident that tax cuts are an effective strategy in reviving the economy. The Keynesian and the supply side perspectives in terms of aggregate demand and supply respectively explain how tax cuts can help in reviving the economy.