Wednesday, February 2, 2011

Permanent vs Temporary Tax Cuts

Permanent vs Temporary Tax Cuts
by Alex Merced

  Let's take a moment and put taxes into perspective, at the end of the day taxes are a price like any price and thus it should have similar effects on behavior like other prices do. A temporary tax cut is like a sale at your favorite store, to create temporary spur of demand to move stagnant inventory. Sales can be a very useful tool for liquidating inventory that otherwise was not selling at full price, although you generally don't put goods that turnover regularly on sale since there is no benefit to doing so. A permanent tax cut would be similar to when a good is reduced in cost to supply, so the savings then gets passed along to the end consumer which just reflects increased productivity in producing that good.

 One may say wouldn't a store have permanent price reductions if demand drops for a particular good, which is entirely possible but once the current inventory is liquidated it's suspect that they may replace the inventory.

 Returning to taxes, taxes are just the price one pays for government and similarly tax incentives can be used for governments to compete (especially between states). Although the effects of Temporary over Permanent is most important when it comes to special tax programs to incentivize purchases of goods. For example a tax credit for investment in capital equipment.

 A temporary credit would cause businesses to make future purchases of capital goods now instead of later, so at the end of the day your moving purchases that would of already occurred to an earlier date in time, which just results in a slump in that industry in the future from which those sales were taken.

A permanent tax credit would reduce the cost regularly scheduled capital expenditures freeing up resources for other expenses which can be used for more investment although since the credit is permanent there is no incentive to move future purchases to the present allowing purchases to remain more evenly distributed inter-temporally (over time).

So when discussing different types of tax incentives it's important to realize that whether it's permanent or temporary has an effect on human behavior and outcome of such policies.


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