A tax cut is a decrease in taxes. Stimulating the economy through tax cuts, deficit spending and interest rate intervention, are some of the key aspects of Keynesian economics. The immediate results of tax cut are, a reduction in the real income for the government and an increase in income for those taxpayers whose rate of tax has been decreased. Even though tax cuts seem to decrease government revenue, in the longer run, this loss of income by the government is mitigated, according to the response of the tax-payers.
Depending on the previous rate of tax, a tax cuts provides corporations and tax payers with the incentive to investments hence stimulate the economy. This has been theorized based on Laffer curve which shows that additional taxable income can be generated when the tax rate is low as compared to when it is high since tax cuts will increase disposable income for households and thereby increase consumption.
The government may use fiscal policy to add to the populace the money available, this is known as expansionary fiscal policy. Examples of this are raising government spending and lowering taxes rates. When the government applies fiscal policy to lower the supply of money available to the population, this is called contractionary fiscal policy. Examples include lowering government spending and increasing taxes. Expansionary fiscal policy increases output levels, or national income, where as contractionary fiscal policy lowers the output, or national income. Thus the government can improve the economy by using the expansionary policy rather than the contractionary policy since the private sector is highly resourceful in spending money as compared to the public sector. Government spending is more wasteful, and has high bureaucracy costs.
Tax multipliers are founded on the people's willingness to consume. Marginal propensity to consume is used to measure this willingness. A high marginal propensity to consume shows a large amount of consumption and a minimal amount of savings. When a tax cuts occurs, consumers save part of their income and spend a part of it. This therefore shows that tax cuts helps to improve the economy as a large sum of money is in the hands of individuals who spend it rather than hold on to it. In general tax cuts has its merits and demerits hence it's upon the government to implement its policy's in a way so as to bring about economic development and growth.