Sammy on Tax Cuts, Response by Cactus

Sammy sent me the following…

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Title: Effect of a tax cut on a Simple Economy

There is constant debate on the effects of tax cuts and government spending on economic output. The analysis consists of examining historical data to discover correlations, but both sides come to opposite conclusions because of time lags, measurement problems, and most importantly, the effect of exogenous variables.

So what if we were to construct a model that excludes as many of these variables as possible so as to isolate the effect of tax cuts and government spending on a hypothetical economy.

Imagine a simple economy where economic output is measured in bushels of wheat (as a proxy for GDP).

Other conditions:

1) 100 workers produce 10 bushels of wheat each for a total of 1,000 bushels per year.

2) Production of wheat remains directly proportionate to the labor input.

3) All group support functions ie medical, organizational etc are in stasis to support those 100 workers.

Now, to simulate the effect of government/taxes imagine 30 of those workers are diverted by government to some other function – digging holes and filling them up, “R&D”, whatever those huge buildings full of government workers do, anything except producing wheat.

Since condition 2) above holds, output of this economy measured by bushels of wheat is now 700, not 1,000.

Now one may debate, as liberals will, that those 30 diverted workers produce some other meaningful benefit, but they cannot refute that output, measured by bushels of wheat, declines.

This is what tax cuts (dollars are productive labor in physical form) and reductions in government do. They return more labor/resources to the production of wheat.

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This was by Sammy. Cactus here – Sammy is right, but I think I can provide the liberal response:

If everyone is doing the wheat farming, nobody is building the road that allows the the farmers to get wheat to market. If the government taxes each farmer by requiring X number of days of their labor to build roads, the output of wheat will go down in the short run. But it will also allow the farmers to sell the wheat, and to purchase equipment which otherwise would never make it to their farms, meaning that it increases the output of wheat next year by a lot.

And this process is true each year – each year, the government “tax” reduces output below the level it otherwise could be that year, but each year it raises the maximum possible output by producing infrastructure and other things needed to keep the economy going. Each year the output rises… more than it would if there hadn’t been taxes the year before or the year before that.

And one more thing about this story… from here to eternity, most of the farmers are going to complain about the government.