IAI Actuarial Core Principles · Business Economics · Supply-side policies and their impact on businesses
A firm's profit is Rs 100 crore before tax. The corporate tax rate is cut from 30% to 25%, and the firm reinvests the whole of the extra after-tax profit. Assuming pre-tax profit is unchanged, how much extra is available for reinvestment, and which supply-side argument does this illustrate?
Extra after-tax profit is Rs 5 crore, since after-tax profit rises from Rs 70 crore to Rs 75 crore. The supply-side argument is that higher retained funds and post-tax returns encourage investment, which expands capital stock and productive capacity over time.
- ARs 5 crore; lower taxes raise the retained funds available for investment and so potentially capital stock and capacityCorrect
- BRs 5 crore; lower taxes reduce investment because profits fall
- CRs 25 crore; lower taxes mean the firm pays no tax on reinvested profit
- DRs 30 crore; lower taxes transfer the entire tax bill to the firm
- Rs 10 crore; lower taxes double the retained profit
Explanation
Tax at 30% is Rs 30 crore, leaving Rs 70 crore. At 25% tax is Rs 25 crore, leaving Rs 75 crore. The gain is Rs 5 crore. The supply-side argument is that more retained profit and higher post-tax returns encourage investment, expanding capital stock and capacity.
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