Will tax cuts make inflation worse?
Tax cuts are on the agenda in this year’s gubernatorial election. Some are touting this as a way to leave money in people’s pockets to help them cope with the current high rate of inflation, which is one of the issues weighing most heavily on Minnesotan’s minds. But might such tax cuts actually make inflation worse?
That is what Howard Gleckman argued for the Tax Policy Center back in March:
Even as Republican governors blast President Biden and congressional Democrats for both causing inflation and failing to address it, they are promoting their own tax cuts that likely will add to consumer demand and raise prices.
Putting more money in people’s pockets will increase demand for goods at a time of supply shortages. That will drive up prices and worsen the inflation that the governors claim to be so worried about. And it will increase pressure on the Federal Reserve to raise interest rates even more than it planned.
What a deal: In exchange for modest tax savings, people will pay higher prices and interest costs.
This is a curious argument. All a tax cut does is leave money in the pockets of individuals rather than place it in the hands of the government. The ‘extra’ spending power these individuals have resulting from a tax cut is matched by a lower spending power for the government.
If government was less likely to spend this money than the individuals, to ‘sit on it’ in some way, then you could argue that shifting that purchasing power from the government to the individuals would be inflationary. But this runs contrary to what most Keynesian economists argue, which is that the government actually spends a higher share of its income than individuals (this is why they advocate government spending to boost economic activity).
What drives inflation, for the most part, is how much money is being created, not whether it is government spending it or individuals.