What is the impact of proportional taxes?
- AIncreases the marginal propensity to consume
- BReduces the autonomous expenditure multiplier
- CIncreases the induced expenditure multiplier
- DIncreases the autonomous expenditure multiplier
Solution & Step-by-step Explanation
Proportional income taxes reduce disposable income at every level of national income. The aggregate consumption function changes because part of any increase in income goes to taxes instead of consumption.
The formula for the expenditure multiplier with a proportional tax rate t is:
Multiplier=
1−c(1−t)
1
Where c is the marginal propensity to consume (MPC). Because (1−t)<1, the denominator increases, which reduces the overall autonomous expenditure multiplier.
The formula for the expenditure multiplier with a proportional tax rate t is:
Multiplier=
1−c(1−t)
1
Where c is the marginal propensity to consume (MPC). Because (1−t)<1, the denominator increases, which reduces the overall autonomous expenditure multiplier.