Sunday, February 03, 2008

Tax cuts and Recession - Complete Analysis

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If the topic scared you, thats what it was meant to do. Time to brace yourself up and read. And read a lot. GD preparation does not come just by talking. It comes more by listening, reading and discussing. Shake the party mood of CAT victory and dive deep in

Note that logical topics should be dealt with in a very step by step approach. Many of you are straying from the topic try to put out everything you know. Note that in a GD, you will not be able to say everything and if you stray the group will cut you down... and if you keep doing it, they will ignore you.

Below is my take on the topic.
Start: Goverments have but few tools to steer their economies. Tax cuts is one of them. But in any marco-economic scenario the results take time to come in and it is very difficult to attribute one reason to the end result. Any analysis of a macro economic solution hence begins with a "it depends"...

Middle points:
1. Though it is true that tax cuts result in less money in the hands of govt in developed economies, in many developing economies, it has resulted in more money in the hands of the govt. People tend to pay taxes more honestly when the cost of compliance is low
--- This brings in a shift in thinking to many of the group's arguments. It is key in the GD to think broad

2. Tax cuts result in more money in the hands of the people. In a recession, when people are constantly getting hit by bad news, this may not always result in more spending but may just result in more savings. Hence tax cuts have to be necessarily followed by disincentives to save - which means lower interest rates and probably higher tax on interest income.
--- This is a show stealer. You make one such comprehensive comment and not only that the group will listen to you anytime you talk, but the profs would have ticked a 10 on 10

3. To pull an economy away from recession, apart from encouraging spending, it is important to incentivise Production too since GDP is the final measure of success. Tax cuts for corporates increases margins and gives them an opportunity to lower prices, hence curbing inflation and encouraging spending
--- Looking from the other angle. Bringing corporate tax and not just talking about personal tax.

End Game
Though tax cuts look positive for a receding economy, it has to be used carefully and with a host of other tools since it is very difficult to reverse if the need arises.
--- Strong one sided approach in macro economic theories never work. Same thoeries that work for one nation have spelled doom for others

Comments welcome. That is what makes the discussion interesting. I would like people countering the moderator, specially when I take a one sided stand. Come on guys

Points the team put, and my comments are below

Anonymous said... I think tax cuts will add to the burden of the govt and increase the deficit. Ofcourse the tax structure can be changed to benefit certain sections as well as to maximise the revenues.
--- Both sentences are right. But neither have you touched recession, nor the impact of tax cuts on it. Deficit is increased, but is that bad is the question? The key in GDs is not to make generic statements and leave them open ended.

Smriti Mehra said... Well, there is a very relevant topic of today and no country other than US can be a live example of this. Post the dot com bubble and the housing problem, the Govt. as well the Fed are trying to take steps to control the falling GDP growth rates in US using tax concessions as well as by decreasing the interest rates.
--- Good example and strong point. This is good in the middle of the GD though. But avoid starting on a narrow lane. If you begin with US, discussion will move in that direction. If you are starting the GD, set a broad platform and direction.

#1 With the fears of US heading towards recession, we need to take a look at why the tax rates are cut -- my understanding here is they would increase the consumer income and subsequently the consumer spending. US govt has been cutting tax rates over the years, atleast post the dot come bubble, then why hasn't consumption and GDP risen in US ? These are the questions we need to ask before heading towards any conclusions
--- Very good point. A strong point in the middle of the GD, showing the group that before we reach any conclusions, we need to know how tax cuts affected last time

# Post the sub-prime crisis, skeptisms have increased in Investments in US and this is already a detterent to the GDP growth rate. Besides as already pointed out by my friend above, they decrease the income of the Govt, and thus causing budget deficit in the country.
--- Deficit budgets are considered good for growing economy. If the govt has a surplus budget, that means it does not know how to spend the money it collected. Though deficits have to be controlled, they are not bad by themselves

# Even when in India, Mr. P. Chiddambram announced his dream budget in 1997 and announced the tax rate cut although it was hugely welcome by the general public , it failed to have the desired impact. The reasons, though many, but can also be attributed to the Asian crisis, the Harshad Mehta stock market scam and then the dotcom bubble.
--- Good try to get India in picture, but I think you are diverting from the topic, since tax cuts of Chid had nothing to do with recession.Hence, with all these points, I would like say to that merely tax concessions are not the only solution to any economy, and particularly the one heading towards recession.

A bigger combination of the macroeconomic picture along with the consumer sentiment need to be taken into account for deciding whether they will have the desired impact or not.
--- Conclusion not strong enough. Also generic ending does not help. When you conclude, you have to be very specific.

alapatt said... The lesser the tax the better is for the economy, especially for developing countries and countries like India, China, Brazil etc would be the most important benefactors.In India too the finance ministry and the economic advisory commitee to the PM have been showing signs of going in for a cut on taxes.It would fuel market growth and investment Opportunities.
--- Need to get to the point of recession a little quicker

Tax cuts on the higher sides are suited for developed countries because they are already self sufficient and they could afford paying taxes to ensure a good quality life. The best examples are Norway and countries in the scandinavian belt and as a result these countries also figure in the top ranks in the World,s most suited places for buisness.
--- Still not got into the topicIndian market

were the last to get affected by the US down turn(SUB prime and the Bad debt recovery problems), it also shows that Indian markets are evolving in its own way focussing on our domestic needs,so the tax cuts would definetly help in countering our infrastructural and power related challenges, people would be persuaded to spend more.
--- Coming along into the grove nicely now, but note that if you don’t make your points crisp and fast, the group will start talking before you finish.

The deficits in the market can be offset by diluting stakes in the public sector fund holding if at all crunch situations arise. The stakes in the government holding can be lowered till 51% and we have seen signs of this in the case with Maruti,BACLO etc.The stocks are more integrated and the new measures by the SEBI can eliminate fraudsters.The registration of Participatory note holders and short selling concepts with rigorous and concrete checks in place are the right way forward
--- you were coming into some good points above and you moved away completely into a different world altogether here. I am sure you have lot of comments to make on the tax cuts, why are you getting completely diverted?

Jason Bourne said... Let us first look why the US economy is on the verge of recession :1.Slump in House market-Huge Number of Unsold Houses are forcing Real estate prices to go down2.Oil Prices-With oil price approaching $100 a barrel, it is responsible for weaking the purchasing power for other goods.3.Credit Issues-After Subprime Crisis Investors and Lenders are bit cautious and therefore there is liquidity crunch in US economy.
-- Nailed the points clean. Though for a start, US economy is a little narrow.

Although recession has its own downsides like Unemployment,Low Profits,Slow Growth,Low Motivation among Investors but it has few upsides as well like it helps to dampen inflation,helps investors to make careful and strategic long term investments.And thus it is advtangeous for economy in long term
--- Great point. You steal the thunder when you bring in insights like this. The group should note that it is important to analyze the key words in the topic and look at it from all angles

Now let us look at Implications of Tax Cut:1.Some mite argue that Tax Cuts will allow Consumers to take more money home and thereby it will increase their spendings.However in the current scenario most of the consumers are afflicted with debts of different forms and thereby most of the spendings would be to ward off the debt.
--- Correct. But clearing debts help the health of the economy

2.Unnecessary tax Cuts and Interest Cuts will lead to Inflationary pressure and therby can induce a Recession much bigger than current one.
--- Correct and good point. Only that you should have not used the word unnecessary

3.Also they will reduce Money with the Government and theryby increase the deficits.
--- good point again

Utsav said... Tax Cuts are like a double edged sword. Although it increases the spending power of the people, it also increases the deficit. It seems, according to me, a quick fix solution to a reccesing economy.
-- if it is indeed a quick fix solution, then why not

There are other ways to increase the spending in an economy which would help to turn it around. Decreasing the intrest rates, As done by the US Federal reserve recently, would mean that loans become cheaper and more money is available for use by the public.
--- good point

Also it frees up a lot of money that can be invested in other emerging markets like India and China, thus earning high returns.
--- questionable, but good thought.

Another way is for the Government to increase spending. This will lead to increased consumption figures. However in this method, deficit increases.
--- why does everyone hate deficit

In case of Tax cuts, once the Government cuts rates, then it has to rely on the public to increase consumption. It loses control of its own money which can be harmful in the long term w.r.t. developmental projects as the Government has to contend with less spending.
--- good point

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Blogger Gyan-ee said...

A good read on supply side and demand side economics, read

But, as is always true with economics, nothing is outright truth and nothing succeeds everytime

8:59 PM, February 10, 2008  

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