Question

It is late 2019 , and the U.S. economy is showing signs of slipping into a potentially deep recession. Government policymakers are searching for income-tax-policy changes that will bring about a significant and lasting boost to real consumption spending. According to the logic of the permanent income hypothesis, should the proposed income-tax-policy changes involve tax increases or tax reductions, and should the policy changes be short-lived or long-lasting?

Short answer

Tax cuts can increase consumers' real disposable income and consequently their real consumption spending, but the government wants big tax cuts.

Step-by-step solution

Introduction 

The given is about the signs shown by the U.S economy of slipping into a potentially deep recession

The objective is to determine should the taxes be fixed as short term or long term

Step 1

Consumption flows are based on the level of permanent income or predicted long-term average income, according to the permanent income hypothesis.

Increases in predicted long-term average income lead to higher consumption spending, and vice versa.

Step 2

Tax reductions can increase households' real disposable income and thus impact real consumption spending.

However, if the government wants a significant and long-term boost to real consumption spending, it must make the income-tax policy change, i.e. tax reductions, a long-term change because only then can permanent income be increased, resulting in a significant and long-term boost to real consumption spending.