It has a simple, classical ring to it. If taxpayers have more to spend, the additional spending stimulates additional production. Producers then hire more workers and buy more from suppliers, and those workers and suppliers in turn spend what the producers pay them. Thus more income gets generated and more goods and services produced, and so on in a virtuous circle. Conversely, if government wants to restrain total spending - "cool the economy down" - it can increase tax so taxpayers have less to spend. It sounds like nothing more than forward and reverse, addition and subtraction - but when we make the arithmetic explicit, it turns out there's rather more to the story.
The effect of a tax cut, just by itself, is to increase money in the hands of taxpayers by the same amount that money decreases in the hands of government. Whether that by itself changes total spending depends on what taxpayers do with the money compared with what government was doing. If taxpayers spend more of it than government was spending, then total spending will increase. But taxpayers who are already saving some of their after-tax income will probably also save some of their share of the tax cut; so unless the entire tax cut goes to people who will spend all of it, some of it will be saved. Thus unless government was already itself saving at least the same amount of the tax that taxpayers will now be saving, the effect of the tax cut will be to reduce total spending, not increase it. Hmm.
Can it be that when government spends a dollar the effect is somehow less stimulating, all in, than when a taxpayer spends a dollar? No. There are ethical and political questions about who should get to spend a given dollar, but from an economic perspective the dollar gets into circulation either way - it's only a question of where it first enters the economy.
Or is it that when we know there's a tax cut coming, we spend more on the strength of the expected windfall? We spend some of what we were saving, or maybe we even finance additional spending by borrowing against the tax cut, like a payday loan, so that some spending is increased or at least accelerated. Yes, there are some such effects - but they're minor when you compare them to the total amount of money that the tax cut shifts from government to taxpayers.
No, the main truth follows the arithmetic. If the purpose is to stimulate the economy, government has to replace what it loses through the tax cut by borrowing, printing more money, or delaying repayment of amounts already owed, so that it can continue its own spending at approximately the same rate and not simply offset the increase in spending by taxpayers. And notice that if a tax cut were funded by "finding efficiencies," as populists like to promise, that would by hypothesis involve a decrease in government spending. You might, of course, think that's a good thing in itself, but it wouldn't provide any economic stimulus. As we said, the economic stimulus requires that the increase in taxpayer spending not be counteracted by a decrease in government spending.
Now imagine that a government prepares for a tax cut in advance by first borrowing the amount it proposes to return to taxpayers. Then suppose that, just before the scheduled tax refund, the government spends the money instead. You might think that would be unfair, even outrageous, but the economic stimulus would still be there because there would still be an overall increase in spending. In effect, returning money to taxpayers is merely one of a variety of techniques by which government can spend or cause money to be spent. And that brings us back to the main question. It's the spending that causes the stimulus, regardless of the particular technique involved - in our case, tax cuts funded by government borrowing. Tax cuts, just by themselves, don't stimulate the economy much, if at all. So why do we keep hearing that they do?
For the same reason we keep hearing about "Tax Freedom Day," about how our "best" Canadians are leaving in droves for the United States because they're overtaxed here, about the need for "tax reform," which means lower taxes, especially for the upper brackets. Follow the arithmetic. If your main goal as a citizen were to pay the least possible tax - and there are such citizens, if that's the right name for them - you would organize and sponsor initiatives that got others to believe that lower tax is good for independent reasons. It stimulates the economy, it makes you more free, it encourages our best Canadians to stay in Canada, it gets government off the backs of the entrepreneurs who create the jobs. It allows the market to allocate the resources needed to fight poverty, decrease crime, protect the environment, educate the young, reduce discrimination, afford equal opportunity, provide equal access to justice, suppress corruption and ensure transparency of government, care for the sick, promote a sense of community, maintain a nurturing environment that encourages us all to live up to the best that is in us. Amazing, eh?
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