Income tax is usually a progressive tax placed upon people who have an income. By being progressive, it means the more a person earns, the more they will have to pay in tax. Income tax is part of fiscal policy and is a major tool used by the government to influence economic performance. In the short run a reduction in income tax would certainly improve economic performance.
A reduction in income tax will mean households have more disposable income and so will spend more. This is shown by a shift in aggregate demand from AD1 toAD2. This results in an increase in output and Real GDP of Y1 to Y2 however it also increases the price level from P1 to P2. In the short run this rise in prices is accompanied by a rise in output and real GDP and so is acceptable.
However in the Long Run further rises in AD do not cause rises in output and real GDP, instead they only raise the price level
This is shown on the above diagram, where the only rise is in the price level which is described by Monetarists as “the greatest economic evil”.
As part of the fiscal policy, income tax rates are a demand slide policy, which are used mainly to influence economic growth in the short run. Known as Keynsian approach. Monetarists believe the best way to achieve Long term growth is through supply side policies. These include education and training schemes, corporation taxes and infrastructure.
They are all aimed at increasing output and real GDP.
As seen above Real GDP and output have increased with no rise in the price level. There are problems with this however; the time taken for an effect to be seen can be very long, also supply side policies cost the government a lot of money and so may actually lower AD in the short run due to less government spending on benefits and increases in households taxes to fund these policies.
Therefore I think the best way to improve the performance of the