President Bush lowered taxes on capital gains and dividends in 2003. Explain how this might increase aggregate supply
What will be an ideal response?
A lender earns a capital gain if she purchases an asset such as a stock at a particular price and then sells it later at a higher price. This difference in price is the capital gain, and is subject to taxes. If capital gain taxes are lowered, the after-tax rate of return on stocks will rise.
Dividends are corporate profits that get redistributed to stock shareholders. These are taxed, and the lower the tax, the greater the after-tax rate of return to investing in a stock that pays a dividend.
Increasing this after-tax rate of return will increase the household's willingness to save and raise the supply of loanable funds. This will lower the interest rate and encourage firms to purchase new capital. This increases the capital stock and aggregate supply.
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