German Tax Reform 2004 Essay

1700 words - 7 pages

IntroductionThe planned tax reform which should be brought forward from 2005 to 2004 was supposed to put around 26.0 billion (amounting to 1.2% of GDP) back into German people's pockets. But after the compromise between CDU and SPD the mixed tax reform for 2004 saves only 22 billion for the people. This amount is not available for the most households because other limitations and regulations like the abolition of "Eigenheimzulage" reduce the surplus to a minimum for most of the taxpayers. The survey from Emnid illustrates the situation in the population. More than three-quarter of the population did not expect an increase of demand [Picture 1].Germany is in a recession [Picture 2]; the economy is under pressure and can not work high efficiency because of low demand. Higher demand and a lower unemployment rate can bring Germany trough the Recessionary Trough.The German government uses the Keynesian model of expansionary fiscal policy to reduce the income taxes and achieve a higher amount of potential outcome. This reduction should increase the national income of the population and in consequence the consumption expenditure of the households. Picture 3 illustrates the key markets which are mainly influenced by the tax reform and set the framework for this assignment.Question IWhat can be the effects on aggregate demand and supply in the short run, on growth and potential output in the long run?The result of the combined tax reform of the German government in 2004 is that German households have in the first moment without looking on other influences and regulations more income after tax. Picture 3 demonstrates more national income (green) as the result of lower taxes (red). This increased income influences in a short term the aggregate demand in a positive way (Picture 3: consumptions, green), under the optimistic assumption that the additional money would be spend without savings (Picture 3: net savings, green). Picture 4 illustrates the shift to the right AD1""AD2.The stronger demand and the shift to the new Price level P2 improve temporarily the profit margins for suppliers. The output for goods and services increases. The real GDP increases as a consequence of the higher supply, demand and income. The aggregated supply is not influenced by the tax reform because the cost for work and the production capacity is still the same only the income taxes are reduced. Picture 3 demonstrates that only the income taxes are influenced.As a result of reduced taxes and increased consumption expenditures has the government a huge budget deficit which has to be balanced by other taxes or money which comes from private domestic or foreign sources (Loan able funds market, Picture 3, red).In the long run the effects of the higher income of the population as result of the lower taxes shift the LRAS towards the right (Y2). A general higher outcome is realized if the income surplus is used for consumption and the aggregated supply will increase as result of more...

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