IAI Actuarial Core Principles · Business Economics · Supply-side policies and their impact on businesses
A government reduces the marginal rate of income tax on high earners, arguing that this will raise the amount of labour supplied and so increase potential output. Which statement best describes this as a market-based supply-side policy?
Cutting marginal income tax rates is a market-based supply-side policy because it strengthens incentives to work and supply labour. If successful, productive capacity rises and long-run aggregate supply shifts to the right, rather than the policy operating mainly through demand or direct state control.
- AIt aims to strengthen work incentives and so shift long-run aggregate supply to the rightCorrect
- BIt aims to raise aggregate demand directly through higher government spending
- CIt aims to reduce the money supply and so control inflation
- DIt is an interventionist policy that replaces market signals with state direction
- It aims to reduce the trade deficit by making imports more expensive
Explanation
Lower marginal tax rates raise the post-tax reward for working, which is intended to increase labour supply and effort. This increases productive capacity, shifting long-run aggregate supply right. It works through incentives, not through demand management or state direction.
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