In 2009, there was an economic recession in many countries. One aspect of the recession was that unemployment rose. Governments paid large subsidies to a number of industries to try to stop the rise in unemployment. This increased the government’s debt and affected its other expenditure. In an attempt to recover part of the extra expenditure, some governments increased income tax rates on people who had high salaries. However, critics of this policy argue that higher tax rates do not work. They say that the proportion of revenue received from top taxpayers falls and does not rise as taxes increase and the higher taxes cause damaging effects on the economy. It is better, they say, to decrease taxes. The decrease in taxes brings the government more revenue, not less revenue. Their opinion is supported by evidence from the past, as is seen in the effect on tax receipts of changing tax rates in the US as shown in Figure 9.31.

It is suggested that this opposite policy of reducing tax rates is better. Lower tax rates actually boost both the economy and tax revenues. For example, Russia, Latvia and Estonia reduced their highest tax rate and replaced a complicated system of taxes with a single income tax rate of 10%. They enjoyed a huge economic boost as a result. Another aspect of the recession was that businesses found it difficult to borrow money from the commercial banks. In order to try and make borrowing easier and help businesses, some central banks lowered their interest rates. The central banks also bought government bonds in an attempt to increase the supply of money in the economy. 

a. Explain what is meant by a recession.

b. The article states that ‘higher tax rates do not work’.
i. What does the article mean by this statement?
ii. Is there enough evidence in the article to justify this statement?

c. Discuss why the actions of the central banks mentioned in the article might have been expected to ease the recession.

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What the top 1% paid in tax Top-rate income tax cuts Proportion of total tax revenue 30% Ronald Reagan US President: 1981-1989 27.5%- 25 17.6% 20 +15 1988 70% 28% 1981 Figure 9.31 Cutting taxes raises revenue