Final answer:
LIFO cannot provide permanent tax savings in theory because the savings are dependent on prices continually rising. If prices stabilize or decline, the LIFO-related tax savings can reverse. Furthermore, permanent changes in fiscal policy tend to have a stronger effect on behavior than temporary ones.
Step-by-step explanation:
The student is asking why LIFO (Last-In, First-Out) cannot provide permanent tax savings in theory. In accounting, LIFO is an inventory valuation method that assumes the most recently purchased items are the ones to be sold first. In periods of rising prices, LIFO shows higher cost of goods sold and lower profits, which can lead to tax savings. However, these tax savings are not permanent because they depend on price levels continually rising. If prices stabilize or decline, the tax savings can reverse, as older, less expensive inventory gets sold off, leading to lower cost of goods sold and higher taxable income.
When discussing fiscal policies, a temporary policy such as a tax cut or spending increase is expected to last a short time and then revert back to its original state. A permanent policy is conceived to remain in place indefinitely. Individuals and businesses tend to respond more strongly to permanent changes, as these affect long-term planning. The theory of permanent versus temporary tax effects relates to the idea that permanent tax cuts would be more effective than temporary ones at influencing behavior because they are expected to last and thus affect future planning.
Additionally, it's important to understand that tax savings from LIFO could lead to the adverse long-run effect of reducing national savings and future living standards, adhering to the principle that tax cuts have the potential to stimulate demand in the short term at the expense of long-term capital accumulation.