Income tax cut → Employment: chain of analysis

ChainWhat it assumes · how to break it

Start

The government cuts the basic rate of income tax, for example from 20% to 18%.

As a result, the take-home pay from each hour of work rises.
net wage

Assumes: The worker earns above the personal allowance.

But: Many low-paid part-time workers earn below the allowance and see no change.

This means the gap between income in work and income on benefits widens, so taking a job pays more.
unemployment trap · replacement ratio

Best link to attack
Assumes: People are unemployed because work does not pay enough.

But: Most unemployed people already want work; the barriers are often skills, location or childcare, which a tax cut does not fix.

Consequently, more people join the labour force and search for work, and labour supply shifts right.
labour force participation

Assumes: The substitution effect outweighs the income effect.

But: Higher earners may choose more leisure instead, so total hours worked may barely change.

In addition, higher disposable income raises consumption and AD, so firms need more workers.
derived demand

Assumes: Firms respond to higher demand by hiring.

But: If the gain is saved, there is little extra demand for labour.

End

Employment rises, and voluntary and cyclical unemployment fall.

Evaluation chainattacks link 2 · Alternatives

E1However, the rise in employment depends on why people are out of work.
E2Because many unemployed and inactive people face barriers such as missing skills, ill health, caring responsibilities or distance from jobs, a higher take-home wage does not reach the cause.
E3As a result, labour supply changes little for the groups the policy is meant to help.
E4So the tax cut may do little to reduce unemployment, and targeted policies such as training, childcare support or in-work benefits may work better.

Can you say this chain from memory?
Members can hide the links, test themselves and track which chains they have mastered.

Explain how a reduction in income tax might reduce unemployment.
Assess the effectiveness of tax cuts as a supply-side policy.
Discuss the policies a government could use to increase labour force participation.

Labour market: labour supply shifts right; or AD/AS with AD and LRAS shifting right.

Income tax rise → work pays less → weaker incentives to take a job.

GCSE version