Should US Congress approve tax cut?

The question is raised now whether US Congress should pass the tax cut bill. There are pros and cons involved with this tax cut bill being debated in US Congress. They are:

First, If the tax cut is approved, the Government budget deficit will increase (as govt revenue goes down) to a new height (currrently, it is almost 1.3 trillion). As a result, Govt will have to borrow more to finance its deficit, so total debt will be hieghtened further. Currently debt is almost 14 trillion, 100 percent of US economic size or GDP ( GDP is the total value of goods and services produced in a year)

Second, If there is a tax cut, certainly investment by the business and spending by the households would be boosted. Hence more employment and output.

As interest rate is gone down to almost zero percent and the tax cut is on its way, US economy is likely to experience at least 3-4 percent growth in 2011 and 2012 if other factors remain unchanged. Hence, more employment and output. But this enhancement will be achieved at the cost of increased govt debt (due to tax cut).

Third, if the economy really tends to grow at 3 percent or more in 2011 and 2012, Prof Bernanke, the Chief of US Central Bank is likely to come down hard with his monetary weapons. They are likely to mop up excess liquidity from the financial system by selling bond from Central Bank's possession. This mop up procedure will be conducted to reduce excess demand so as to control inflation.

Forth, As I said, US Central Bank is injecting USD 600 billion now to lower the interest rate. But Central Bank only can control the short run interest rate but not long run. If you see the current Yield to Maturity (YTM) curve, you will find that it is steeper now meaning that yield of the bond will go up in the long run especially in the case of treasury bonds linked with 10 years and 30 years maturity. In other words, we are expecting higher interest rates in the long run.

Interest rate will be high in the long run meaning that economy will be growing at a faster rate in future as has been reflected in the steeper Yield to Maturity (YTM) curve.

Long run fixed mortgage rates are all on the rise (in case of fixed mortgage rates) as they normally follow Yield to Maturity (YTM) curve of the treasury bonds. As a result, long run industries especially housing one may be affected adversely due to hike mortgage rates.


Since economy is likely to experience inflation in the long run due to tax cut, it would be preferable to invest in stocks rather than bonds as bond prices will be lowered in the long run as YTM will be on the rise in future.

I am expecting 3-4 percent growth in 2011 and 2012 due to tax cut and low interest rate but the whole process will be nullified if the Central Bank fails to contain inflation, likely to come due to excess spending.

Historically we have observed that inflation is the most disturbance element for an economy as it eats up our asset, income and standard of living. 


So if there is tax cut,  employment and economic growth will be accelerated but at the cost of debt. So we have to decide which one we prefer.

Should we accept debt for attaining lower unemployment rate? I would like to discuss this issue in another article.

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