Question

Explain why the tax multiplier is smaller in absolute value than the government expenditure multiplier.

Answer 1

The tax multiplier is negative, which implies that an increase in taxes leads to a fall in output; it is smaller in absolute value than the spending multiplier. We can say higher taxes reduce the people's disposable income, thereby reducing their consumption.

Explanation by taxing an example:

Supose MPC = 0.90

Government expenditure multiplier $=\frac{1}{1-0.90}$

$=\frac{1}{0.10}=\frac{100}{10}=10$

Tax multiplier $=\frac{-c}{1-c}=\frac{-90}{1-0.90}=\frac{-0.90}{0.10}=-9$

Thus, it is clear that the government expenditure multiplier is more than the tax multiplier.