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.

• 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.

• 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).

• Expansionary Versus Contractionary Fiscal Policy

  • This means deficit spending and decreased taxes when an economy suffers from a recession and decreased government spending and higher taxes during boom times .
  • There is a multiplier effect that boosts the impact of government spending.
  • In addition to changes in spending, the government can also close recessionary gaps by decreasing income taxes, which increases aggregate demand and real GDP, which in turn increases prices.
  • Conversely, to close an expansionary gap, the government would increase income taxes, which decreases aggregate demand, the real GDP, and then prices.
  • This means increased spending and lower taxes during recessions and lower spending and higher taxes during economic boom times.

• Corporate and Payroll Taxes

  • Many countries impose a corporate tax, also called corporation tax or company tax, on the income or capital of some types of legal entities.
  • The taxes may also be referred to as income tax or capital tax.
  • The effective tax rate is the average corporate tax rate on the company's income and this takes into consideration tax benefits included in a current tax year.
  • Corporations are also subject to a variety of other taxes including: property tax, payroll tax, excise tax, customs tax and value-added tax along with other common taxes, generally in the same manner as other taxpayers.
  • Deductions from an employee's wages are taxes that employers are required to withhold from employees' wages, also known as withholding tax, pay-as-you-earn tax (PAYE), or pay-as-you-go tax (PAYG).

• Comparing Marginal and Average Tax Rates

  • An average tax rate is the ratio of the total amount of taxes paid, T, to the total tax base, P, (taxable income or spending), expressed as a percentage.
  • Broadly, the marginal tax rate equals the change in taxes, divided by the change in tax base, expressed as a percentage.
  • A progressive tax is a tax in which the tax rate increases as the taxable base amount increases .
  • A regressive tax is a tax imposed in such a manner that the average tax rate decreases as the amount subject to taxation increases .
  • A proportional tax is a tax imposed so that the tax rate is fixed, with no change as the taxable base amount increases or decreases.

• Taxes

  • Examples of an indirect tax include sales tax and VAT (value added tax).
  • Progressive Tax: The more a person earns, the higher the tax rate.
  • Regressive Tax:In a regressive tax system, poorer families pay a higher tax rate.
  • Although a regressive tax system is never explicitly used, some claim a sales tax is a type of regressive tax.
  • Categorize types of taxes into ad valorem taxes and excise taxes