Why is the tax multiplier smaller than the government spending multiplier?
Why is the tax multiplier smaller than the government spending multiplier?
When government expenditure increases in the economy, the aggregate demand increases by the same amount in the first round in the multiplier process. Thereafter, it rises in accordance with the marginal propensity to consume.
On the other hand, a reduction in the taxes increases the disposable income of individuals, and only a part of it that is consumed is used to raise the aggregate demand. Another part of the increased disposable income will be used as savings.
Thus the degree of change in aggregate demand caused by a change in government spending is larger than that caused by a change in tax. The government spending multiplier is 11−c and the tax multiplier is −c1−c.
When government expenditure increases in the economy, the aggregate demand increases by the same amount in the first round in the multiplier process. Thereafter, it rises in accordance with the marginal propensity to consume.
On the other hand, a reduction in the taxes increases the disposable income of individuals, and only a part of it that is consumed is used to raise the aggregate demand. Another part of the increased disposable income will be used as savings.
Thus the degree of change in aggregate demand caused by a change in government spending is larger than that caused by a change in tax. The government spending multiplier is 11−c and the tax multiplier is −c1−c.
