Tax multiplier

Examples of Tax multiplier in the following topics:

• Fiscal Levers: Spending and Taxation

  • The increase in spending and tax cuts will increase aggregate demand, but the extent of the increase depends on the spending and tax multipliers.
  • The tax multiplier is the magnification effect of a change in taxes on aggregate demand.
  • However, the tax multiplier is smaller than the spending multiplier.
  • In contrast, the tax multiplier is always negative.
  • The tax multiplier is smaller than the government expenditure multiplier because some of the increase in disposable income that results from lower taxes is not just consumed, but saved.

• How Fiscal Policy Relates to the AD-AS Model

  • In pursuing expansionary policy, the government increases spending, reduces taxes, or does a combination of the two.
  • An increase in government spending combined with a reduction in taxes will, unsurprisingly, also shift the AD curve to the right.
  • The extent of the shift in the AD curve due to government spending depends on the size of the spending multiplier, while the shift in the AD curve in response to tax cuts depends on the size of the tax multiplier.
  • If government spending exceeds tax revenues, expansionary policy will lead to a budget deficit.
  • If tax revenues exceed government spending, this type of policy will lead to a budget surplus.

• Fiscal Policy and the Multiplier

  • Fiscal policy can have a multiplier effect on the economy.
  • In addition to the spending multiplier, other types of fiscal multipliers can also be calculated, like multipliers that describe the effects of changing taxes.
  • The size of the multiplier effect depends upon the fiscal policy.
  • The multiplier on changes in government purchases, 1/(1 - MPC), is larger than the multiplier on changes in taxes, MPC/(1 - MPC), because part of any change in taxes or transfers is absorbed by savings.
  • For example, the government hands out $50 billion in the form of tax cuts.

• Automatic Stabilizers

  • The unemployed also pay less in taxes because they are not earning a wage, which in turn decreases government revenue.
  • Because more people are earning wages during booms, the government can collect more taxes.
  • When this multiplier exceeds one, the enhanced effect on national income is called the multiplier effect.
  • The multiplier effect occurs as a chain reaction.
  • Taxes are a part of the automatic stabilizers a country uses to minimize fluctuations in their real GDP.

• Tax Deductions

  • A tax deduction is a reduction of the amount of income subject to tax.
  • After-tax cost = 1,000 x (1-0.35), so after-tax cost = 650
  • A tax deduction is a sum that can be removed from tax calculations.
  • To determine the after-tax cost of a deductible expense, we simply multiply the cost by one minus the appropriate marginal tax rate .
  • For example, a tax credit of $1,000 reduced taxes owed by $1,000, regardless of the marginal tax rate.

• Limits of Fiscal Policy

  • For example: if the fiscal authority raises taxes or cuts spending, then the monetary authority reacts to it by lowering the policy rates and vice versa.
  • Chartalists argue that deficit spending is logically necessary because, in their view, fiat money is created by deficit spending: one cannot collect fiat money in taxes before one has issued it and spent it, and the amount of fiat money in circulation is exactly the government debt – money spent but not collected in taxes.
  • When this multiplier exceeds one, the enhanced effect on national income is called the multiplier effect.
  • How effective fiscal policy is depends on the multiplier.
  • The greater the multiplier, the more effective the policy.

• Weighted Average Cost of Capital

  • In order to calculate WACC, a few inputs must be known, namely, the cost of debt, the cost of equity, and the company's marginal tax rate.
  • As the above equation states, the cost of debt, rD(1 - T), is multiplied by the ratio of debt to total market value of the company.
  • This is then added to the cost of equity, rE , multiplied by the ratio of equity to total market value.
  • T is the company's marginal tax rate.

• How Fiscal Policy Can Impact GDP

  • Expansionary fiscal policy can impact the gross domestic product (GDP) through the fiscal multiplier.
  • The fiscal multiplier (which is not to be confused with the monetary multiplier) is the ratio of a change in national income to the change in government spending that causes it.
  • When this multiplier exceeds one, the enhanced effect on national income is called the multiplier effect.
  • The multiplier effect has been used as an argument for the efficacy of government spending or taxation relief to stimulate aggregate demand.
  • If the builder receives $1 million and pays out $800,000 to sub contractors, he has a net income of $200,000 and a corresponding increase in disposable income (the amount remaining after taxes).

• The Money Supply Multipliers

  • Currency-deposit ratio would increase if people evaded taxes or participated in illegal activities.
  • Money multiplier becomes the term within the brackets.
  • Money multiplier equals 2.8.
  • We derive the money supply multiplier for M2 similarly.
  • The M2 money multiplier exceeds the M1 always.

• Combining Operating Leverage and Financial Leverage

  • To calculate total leverage, we multiply Degree of Operating Leverage by Degree of Financial Leverage.
  • Earnings can be measured in terms of EBIT, earnings before interest and taxes, or EPS, earnings per share.
  • Another way to determine total leverage is by multiplying the Degree of Operating Leverage and the Degree of Financial Leverage.
  • Fully derived, we see that to multiply Degree of Operating Leverage and Degree of Financial Leverage, we subtract fixed costs and interest expense from the total contribution margin (revenue minus variable cost times the number of units sold), and divide total contribution margin by this result.