MBA in 2 Minutes | Lesson 21: Long Term Mindset of an Economist

We will be solving practical challenges through MBA concepts. No theory only applications!

As an economist, one has multiple levers at his/her discretion to boost GDP growth.

Step 1- At a fundamental level, there are 3 sources of economic growth-

1. Capital accumulation (savings= investment)

2. Human Capital Acquisition (labour)

3. Productivity Growth (technology innovation)

From above 3 fundamentals, we derive below popular growth policy levers-

1. Capital Taxation (direct and indirect)

2. Industrial Policies

3. Patents and R&D

4. Power of Institutions

5. Growth and Inequality

Step 2 - As an Economist, you are always at a trade off because resources are constraint.

In this lesson, we are going to be deep diving into how reducing capital taxation is a measure used by economist. Interestingly it might lead to short term turbulences but can drive long term GDP growth even if it comes at an expense of reduction of government revenue.

This point is extremely important in democratic setups as many times politicians and economists are at war because politicians intend to solve for short term while economists tend to solve for long term.

Step 3- To start with, let me share few examples of capital gains taxes as corporate taxes, divident tax etc.

Short term disturbances due to capital tax reduction:

1. A temporary capital gains tax reduction possibly could have a negative impact on short-term economic growth because of impact on national savings. A temporary tax cut could induce investors to sell stock (i.e., realize capital gains by reducing the lock-in effect), but provides no incentive to invest since investors know they will face higher tax rates in the future.

2. However, an effective short-term economic stimulus can increase aggregate demand, which requires additional spending.

Long term economic growth due to capital tax reduction:

1. In the long term, reductions in capital taxes increase the after‐tax return on saving and should increase savings rates.

2. Hence, it is the committed long term capital tax reduction that historical evidence also suggests that tends to increase tax revenue.

If you wish to further delve deeper the details of this lever, you can read this research paper more in depth on US economy. The article clearly brings out the positive impact of capital tax reduction in long term.

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