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ACCA Applied Knowledge · Business and Technology · Macroeconomic factors

A government reduces the corporate tax rate and cuts the marginal rate of income tax on higher earners, arguing that this will encourage enterprise and effort. A critic argues that the policy may not achieve its goal. Which of the following is the strongest valid criticism specific to this supply-side approach?

The strongest criticism is that supply-side tax cuts take a long time to raise productive capacity and may mainly widen income inequality, with uncertain effects on work effort. They do not automatically create a budget surplus, directly set interest rates, or inevitably cause inflation.

  1. ALower tax rates inevitably cause demand-pull inflation within the same year
  2. BSupply-side tax cuts take time to affect productive capacity and may mainly widen income inequality without boosting effortCorrect
  3. CTax cuts always increase the government budget surplus immediately
  4. DReducing tax rates directly raises interest rates set by the central bank

Explanation

Supply-side tax incentives work slowly, as behaviour and investment change over time, and the benefits may go mainly to higher earners, widening inequality while effects on effort are uncertain. Tax cuts do not automatically raise the surplus, they do not directly set interest rates, and inflation is not inevitable.

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