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Anticipating a tax cut

Dear OTA,

Please help me with the attached question.

Thanks in advance!

One page total (including graphs).
Suppose you anticipate that the "Bush tax cuts" on capital gains and income will be reversed next year (or, more accurately, be allowed to expire). You believe the higher capital gains taxes will have a negative impact on capital formation.
Depict on the classical model (not Keynesian) the impact this will have on Aggregate Supply. Make sure you explain each change on the graph. Given your analysis what impact will this have on inflation if the FED continues its current monetary policy (i.e. keeps the Federal Funds rate relatively low).

The answer is pretty much the opposite of this answer below.
Bush's 2003 Tax Act's provisions lowered the rates on long-term capital gains to 15% for taxpayers in the 25% bracket or higher and lowered the 10% rate to 5% for individuals in the 10% and 15% tax brackets, effective from May 6, 2003, through December 31, 2008. The proponents of tax cut polices argued that capital gains tax cuts boosted the economy and increased federal revenues. (i.e During these years, tax receipts has surged.) This has led to an increase in capital gains receipts resulting from higher capital gains realizations. Ultimately, increase in capital has led to enormous growth in the stock market that has occurred since 2003.
One of the important arguments by the Congress for reducing the capital gain tax rates was to stimulate consumer spending. The supply side economists argued that capital gains tax cuts motivate the people to start their own business.
However, capital gains tax cuts was also criticized on the grounds that the tax reductions are only temporary. They may raise the tax receipts initially but lose a larger amount of revenue in the long run. Capital gains tax cuts induce stock sales, but this will cause downward pressure on stock prices in the market. Besides, the opponents argued that the savings from the capital gains tax cut would be concentrated among higher-income individuals, and as a result the savings were less likely to be spent and would produce only a small economic stimulus.


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The solution provided is a superficial treatment of capital gains. It addresses the issue in layman's terms, but does not utilized the Classical model as your assignment requests.

To properly respond to the question, we need to examine the classical model. From the classical economist's point of view, remember the two basic theories of classical economics: Say's law (supply creates its own demand) and price-wage flexibility. Basically, wages and profits paid out during the production of goods are equal to the total sum required to buy them, and that they can always be ...