Impact of tax cut policy on public debt

Custom Student Mr. Teacher ENG 1001-04 24 September 2016

Impact of tax cut policy on public debt

Public debt is also known as government debt. It involves the total amount of money that is owned by any government at a particular time as the government engages in deficit spending. Tax cut can be achieved through different ways. First, the government can cut its expenditure as the individuals increase theirs on commodities that are sourced from within, the government can maintain its expenditure while the tax payers increase theirs on commodities from within, and finally the government can decide to maintain its expenditure as the individuals save their income or use it spend for commodities outside the country.

Tax cut policy is implemented to generally decrease the real income of the government and then consequently increase the real income of the individuals or organizations that have experienced a lowering of tax. The main aim of tax cut by many governments is to provide their citizens and organizations with better incentives for their investments opportunities and consequently boost the economic activity in the country. Therefore, this type of policy provides a number of short term and long term macroeconomic effects on the public debt of any government (Larson 9).

The government borrows funds from both internal and external sources in order to fund the tax cut. This means that in the short run the amount of public borrowing will have to rise higher above the normal level. As a result of this the tax cut policy will boost the economic growth as it diminishes the requirements of borrowing of the government due to the requirement to pay the borrowed money. This scenario is likely to occur in the long run period when the government pays back the borrowed money.

On the other hand, tax cut policy might have a positive impact on the economic growth of an economy as the government increases its public debt (Larson 9). This occurs in a situation where the government experiences an economic recession. At this time, the average propensity to consume by the consumers reduces as people are forced to spend some of the tax cuts which influence the government to borrow sharply because of the needs of the economic stabilizers such as higher expenditure on unemployment benefits and also money for lowering the tax revenue.

Federal debt consists of the public debt. It is attained when an agency of the government called the Treasury of the Federal Financing Bank (FFB) engages in borrowing money from other funds, the public, or from the agency debt. This is situation however occurs when only the government authorizes the FFB to engage in borrowing of money from the public or any other account. The mount of money collected from the federal debts is called the federal funds and is usually spent on the federal government other than those that are designed as the trust funds.

Public debt on the other hand, comprises of both internal and external government borrowing. External debt include money from the foreign lenders who may be in form of other governments or international organizations who provide long term funds to different governments. Internal debt includes money from individuals or groups within country. The main distinction that defines the two types of debts is the fact that federal debt may not include the names of individuals, corporations, states, or federal governments and that public debt is made to comprise of about 99 percent of the gross federal debt.

An example of federal debt is in the case of the United States as a combination of federal states. In the recent years, federal debt had grown to higher levels. In the year 2006 there was an estimation that the federal debt had amounted to 8. 4 trillion dollars. This debt was considered to be high as it constituted about 75 percent of the size of the United States’ Growth Domestic Product and also more that 20 percent of the total worldwide debt (Larson 10).

Tax cut has an impact on the level of consumer in an economy, the investment spending and finally on the whole economy. Tax cut is seen an important stimulus for the consumers to spend on commodities. But on the other hand, earlier tax cuts on the consumers will have variable responses which are either to boost the spending of the consumers if there is a permanent change in the tax liabilities or a reduction on consumer spending as the consumers waits until the change in tax is likely to be less permanent.

On the side of the economy of the government, tax cut is seen as a booster to the improvement of economic growth and increase in government spending. Tax cut increases the revenue of the government and also encourages the citizens of a country to increase their expenditure on commodities thus stimulating economic growth and creation of employment opportunities to the citizens.

As seen earlier, tax cuts are aimed at providing individuals and organizations with investment opportunities in the diversification of the opportunities. This is achieved by an increase in private individuals and firms savings which is an encouragement towards new investment motives in a growing economy. At this point, individuals and private firms and organizations are motivated on more incentives to work and also save for their decisions of investing in new incentives in the economy (Larson 10).

As the government increases its expenditure on the public there are many associated effects on the economy. An increase in government expenditure leads to an increase in the private and output consumption thus weakening the trade balance and also the depreciation of the real exchange rate. This means that the economy will be experiencing an imbalance in trade with the trading partner countries thus deteriorating the stability of the economy which has a negative impact on economic development.

In addition to that, the government is seen as being so big such that higher government expenditure retards economic growth by the transfer of the resources from the productive sectors of the economy which lessens their efficiency. Government spending also reduces labor force by creating disincentives to work and also by making the labor markets more rigid as a result of restraining the flow of workers to the expanding industries from the declining industries.

Government expenditure decreases private investment by increasing the interest rates and also reduces the returns of long term investments by the creation of uncertainties in investment. Finally, it is important for a government to spend for the public as a whole to ensure well functioning of markets and also to necessitate economic growth. However, the expenditure must be minimized as excessive spending is associated with more negative effects on the economy and individuals themselves which will force the government to go for more borrowing or public debt (Larson 11).

As the government continues to increase its expenditure, there is an associated reduction of consumption and investment. This concept is known as crowding effect. If for instance, if an increase in government expenditure is financed by government borrowing, it is likely to facilitate the reduction of private investment as a result of an increase in interest rates. On the other hand, if the increase in government expenditure is as a result of being financed by the increase in tax, this will have an impact of a decrease in consumer consumption.

In general crowding out effect is associated with government expenditure and it explains an increase in interest rates as a result of government borrowing in the money market. Crowding out generally occurs as a result of the preference on government borrowing because it is seen as less risky and able to pay the interest rates more easily that individuals and organizations (Larson 11). Therefore, tax cut policy is seen to have a number of positive and negative effects on an economy’s decisions on either public expenditure or government borrowing.

Decisions are needed to be implemented that should try to balance the policy implementation and its effects on the economy at large (Larson 9). It is seen that the policy can lead to economic growth of an economy if correctly utilized. But on the other hand, if more focus is directed towards more government borrowing and expenditure, then there is a possibility of the resulting crowding effect which has negative impacts on the whole economy. Finally, investment opportunities are seen to be affected by the tax cut policy indirectly.


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  • University/College: University of Chicago

  • Type of paper: Thesis/Dissertation Chapter

  • Date: 24 September 2016

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