Fiscal Policy Tools and Proposals to Increase Tax for the Rich

Governments implement their fiscal policy by modifying their expenditure programs and/or altering their taxation policies (Arnold, 2008, p. 229). The government’s expenditure affects the economy’s output in a number of ways. For instance, when the government makes purchases in providing services such as education, infrastructure and health, it influences the amount of output demanded in the economy (Mankiw, 2002). Accordingly, by modifying its expenditure programs, the government would affect the aggregate demand; i.e. increased expenditure increases aggregate demand whereas decreased expenditure decreases aggregate demand (Colander, 2008). Apart from the expenditures that involve the exchange of goods and services, government engages in other expenditures such as transfers in welfare programs. Such transfers increase the aggregate demand by increasing the disposable incomes for target households thus enhancing such households’ propensity to spend (Mankiw, 2002).

To acquire funds to spend, the government imposes various taxes (e.g. income tax and capital gains tax), which serve as its source of revenue. Governments use such taxes as a tool to implement their fiscal policy. To influence economic outcomes through taxation, the government alters the taxation rates in accordance to the prevailing economic environment. Such modification of the rates influences aspects such as consumption and investment, which in turn affect aggregate demand (Colander, 2008). As an alternative to increased spending of the revenue collected through tax, the government could implement expenditure programs by giving certain individuals tax reliefs. The reliefs have similar effects to government expenditures aimed to increase households’ disposable income; they increase the disposable income thus encourage consumption and investment, which result into an increase in aggregate demand (Mankiw, 2002). Accordingly, the government can influence aggregate demand by altering its taxation and expenditure approaches.

The government expresses its taxation and expenditure programs through annual budgets that it usually presents to the House of Representatives for approval. A balanced budget occurs when the government’s projected expenditure equals the revenue it derives from taxation (Mankiw, 2002). Although this is the ideal situation because it indicates that the government will collect an appropriate amount of revenue that it will dispense appropriately, the reality for many governments has been to run a deficit. For instance, in the US, since 2001 when the government run a budget surplus of $128,236 million, the subsequent years have been years of budget deficits with the 2011 deficit ($1,299,595 million) being the highest recorded (US Government Printing Office, 2011, pp.22-23). The deficit is estimated to increase in 2012 then decrease subsequently though the budget is expected to remain as a deficit even past 2017, the final year for which projections are available (US Government Printing Office, 2011, p.23; Easterbrook, 2011).

Deficits occur when the budgeted government expenditure exceeds revenues. When such is the case, the government funds the deficit by issuing government debt through the financial markets (Arnold, 2008). Surpluses, on the other hand, occur when the government revenues from its projected tax proceeds exceed its expenditure plans. In such a scenario, the government can use the extra amounts to repay the debts it has incurred in periods of deficit (Mankiw, 2002). Accordingly, a government that runs successive periods of deficit incurs a high risk due to accumulated debt that reduces its capacity to engage in future expenditure programs. Such reduced capacity affects government ability to spur economic growth for instance during periods of recession.

In the US, a recent policy proposal has been to increase taxation for the rich as a way of reducing the budget deficit and addressing income inequality in society. The taxation proposal was to increase the minimum tax that Americans making more than $1 million pay to the federal government (Calmes, 2011). It was aimed to replace the alternative minimum tax (A.T.M), which sought to address the income inequality since the late 1960s, but has subsequently become ineffective as more Americans considered to be in the middle class, attain incomes subject to the A.T.M (Calmes, 2011). The recent proposal is for the rich individuals to pay at least equivalent percentage of their income as that paid by middle-income earners (Calmes, 2011). The proposal has had support from individuals such as Warren buffet but has faced a great onslaught from the republicans, who have historically opposed increased taxation for the rich. Furthering the opposition to such increased taxation, is a claim that increased taxation would lead to reduced investment because the individuals who are taxed more would have lower disposable incomes thus reduce their investment (Calmes, 2011; Mankiw, 2002). Accordingly, lower investment would influence aspects such as employment levels, which, in turn, affect the aggregate demand in the economy.

Subsequently, the proposed higher taxation for the rich has been suggested as a way to reduce the budget deficit that the government is running (Easterbrook, 2011). However, a counter argument has been that a better approach would be to reduce tax reliefs offered on various claims thus increase government revenue (Porter, 2012). To support this counterargument, examples of tax breaks that have failed to realize their desired effect are cited. For instance, Porter (2012) reports that tax breaks provided on mortgages to boost home ownership among individuals with low incomes do not serve that purpose. Instead, such tax deductions only assist individuals who already have the capacity to own homes to buy bigger houses or buy more houses (Porter, 2012). Accordingly, the effect of the policy is that the government loses a substantial amount of income while failing to achieve the effect it desired by offering the tax breaks. In the subsequent section, this paper considers the effect of increased taxation on the rich on the aggregate demand and aggregate supply. Go to part three here.

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