Impact of Taxes

Taxes also upon equilibrium GDP, although the size of tax multipliers is smaller than that, of expenditure multipliers. Consider the following example: Suppose the economy is at its potential D and the nation raises defense spending by $200 billion. ch sudden increases have occurred at man points in the history of the United States in the early’ 1940s for World War II, In 1951 for the Korean in the l960 s for the Vietnam war and in the early 19805 during the Reagan administration’s military buildup. Furthermore. say that economic planners wish to raise taxes just enough to offset the effect on GDP of the $200 billion increase in G. How much would taxes have to be raised?

The reason the tax multiplier is smaller than the expenditure multiplier is straightforward, When government spends $1 on G, that $1 gets spent directly on GDP_,On the other hand, when government cuts taxes by a dollar, only part of that dollar is spent on . C. while a fraction of ‘that $1 tax cut is saved. The difference in the responses to a dollar, of G and to a , dollar of This enough to lower the tax multiplier be Joe the expenditure multiplier.

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