Arnold Kling

Taxes and the Business Cycle

Arnold Kling, Great Questions of Economics
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State and local governments cannot run deficits, so Alice Rivlin suggests that they would be better off with tax revenues that are insulated from the business cycle.

The fact that states collectively have become more dependent on the income taxation somewhat reduces the fear that their revenues will grow more slowly than GDP over the long run. The price, however, is the greater volatility of revenues over the business cycle...

Because consumption is more stable than income, a tax on consumption would be more stable than an income tax. However, Rivlin points out that because sales taxes tend to exempt services, which are a fast-growing sector of GDP, sales tax growth may tend to lag GDP growth. Also, income taxes tend to be more progressive.

Discussion Question. If it is good for the Federal government to run a deficit during a recession, then is it preferable for the government to use an income tax or a sales tax?

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