Economics
Tax Multiplier
The tax multiplier measures the impact of changes in taxes on overall economic activity. It represents the change in aggregate demand resulting from a change in taxes. A higher tax multiplier indicates that changes in taxes have a larger impact on the economy, while a lower tax multiplier suggests a smaller impact.
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9 Key excerpts on "Tax Multiplier"
eBook - PDF- Irvin Tucker(Author)
- 2018(Publication Date)
- Cengage Learning EMEA(Publisher)
The Tax Multiplier can be computed by using a formula and the information from column 2 of Exhibit 5. The Tax Multiplier ( TM ) is the change in aggregate demand (total spending) resulting from an initial change in taxes. Mathematically, the Tax Multiplier is given by this formula: Tax Multiplier 5 1 2 spending multiplier Returning to Exhibit 2, the Tax Multiplier formula can be used to calculate the cumu-lative increase in the aggregate demand from a $1 trillion tax cut. Applying the formula given above and a spending multiplier of 2 yields a Tax Multiplier of 2 1. Note that the sign of the Tax Multiplier is always negative. Thus, a $1 trillion tax cut shifts the aggregate demand curve rightward by only $1 trillion and fails to restore full-employment equilib-rium at point E 2 . Mathematically, Change in taxes ( ∆ T ) 3 Tax Multiplier ( TM ) 5 change in aggregate demand ( AD ) 2 $1 trillion 3 2 1 5 $1 trillion Tax Multiplier ( TM ) The change in aggregate demand (total spending) resulting from an initial change in taxes. As a formula, Tax Multiplier equals 1 2 spending multiplier. Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 342 PART 3 • The Macroeconomy and Fiscal Policy The key to the amount of real GDP growth achieved from a stimulus package depends on the size of the MPC. What proportion of the government spending increase or tax cut is spent for consumption? The answer means the difference between a deeper or milder recession as well as the speed of recovery.
eBook - PDFAusterity
When It Works and When It Doesn't
- Alberto Alesina, Carlo Favero, Francesco Giavazzi(Authors)
- 2019(Publication Date)
- Princeton University Press(Publisher)
The problem is that an empirical model general enough to incorporate all possible inter-actions between macroeconomic and fiscal policy variables is impossible to estimate because the data available are limited. Thus modeling choices must be made, and they do affect the results. Alternative Ways of Measuring Multipliers Two definitions of multipliers are used in the literature. One looks at the effect on output (or some other macroeconomic variable) of a shift in spending (or taxes) that is not related to the state of the economy, such as during a war. In economists’ jargon an “exogenous” shift in spend-ing, a change that is not caused by the state of the economy or motivated by the need to stimulate the economy. This impact—measured as the ratio of the cumulative change in output to the initial shift in government spending—is computed at various horizons. In other words, assume that in year zero government spending is cut by 1% of GDP: the multiplier is defined as the ratio of the cumulative change in output up to some horizon—say 3 years—divided by the size of the shift in government spending in year zero. The approach has the drawback of overlooking the fact that follow-ing the initial shift, government spending (or taxes) will not remain constant: they will typically keep moving. This suggests an alternative measure: defining “multiplier” the ratio of the cumulative (discounted) output response to the cumulative change in government spending and taxes (also discounted), that is the initial shift, say in spending, plus the shifts in spending that followed the initial exogenous adjustment. This second measure has been advocated by some researchers 3 because 56 Chapter Four it captures the extent to which the size of the multiplier depends on the persistence of fiscal shocks. Although these two measures often produce multipliers of different sizes, when used consistently they rarely result in a different ranking of multipliers.
eBook - PDF- Ľudovít Ódor(Author)
- 2017(Publication Date)
- Cambridge University Press(Publisher)
Second, multipliers depend on the type of spending or tax change, as well as on a host of other factors: Expected sources and timing of future fiscal financing; whether the initial change in policy was anticipated or not; how monetary policy behaves; what is the state of the cycle when the policy is implemented. There is no such thing as a unique fiscal multiplier and the evidence obtained by a specific investigation on the multiplier can be understood only within a general dynamic framework which clearly indicates the specification and identification choices made in that investigation. Bibliography Acconcia, A., Corsetti, G. and Simonelli, S. (2013). Mafia and public spend- ing: evidence on the fiscal multiplier from a quasi-experiment. American Economic Review, 104(7), 2185–209. Alesina, A. and Ardagna, S. (2010). Large changes in fiscal policy: taxes versus spending. Tax Policy and the Economy, 24, 35–68. Alesina, A. and Perotti, R. (1997). The welfare state and competitiveness. American Economic Review, 87, 347–66. Alesina, A., Ardagna, S., Perotti, R. and Schiantarelli, F. (2002). Fiscal policy, profits and investment. American Economic Review, 92(3), 571–89. Alesina, A., Barbiero, O., Favero, C. , Giavazzi, F. and Paradisi, M. (2014). Austerity in 2009–2013. Paper prepared for 60th panel meeting of Economic Policy, October 2014. Alesina, A., Favero, C., and Giavazzi, F. (2015). The output effects of fiscal stabilization plans. Journal of International Economics, 96(1), S19–S42. What Do We Know about Fiscal Multipliers? 477 Auerbach, A. and Gorodnichenko, Y. (2012). Measuring the output responses to fiscal policy. American Economic Journal: Economic Policy, 4(2), 1–27. Bachmann, R. and Sims, E. (2011). Confidence and the Transmission of Government Spending Shocks. NBER Working Paper No. 17063, National Bureau of Economic Research, Inc. Barro, R. J. and Redlick, C. J. (2011). Macroeconomic effects from govern- ment purchases and taxes.
eBook - PDF- Michael Veseth(Author)
- 2014(Publication Date)
- Academic Press(Publisher)
tax expenditures: special tax reductions given for individual spending on approved items. subsidies: government payments to individuals or firms to encourage specific activities. Multiplier Analysis How do government tools affect the economy? The most direct effect is felt on aggregate demand. Changes in government spending, taxing, and transfer payments all end up as changes in aggregate demand. Keynes recognized this fact and added two surprising observations: (1) a change in government spend-ing results in a much larger change in aggregate demand, and (2) we can predict how big the AD change will be. Keynes' insights are based on the analysis of multipliers. An increase of government spending does not just buy missiles or school books or freeway markers. This initial spending sets in motion a chain of con-sumer purchases that raise aggregate demand by far more than the original 182 FISCAL POLICY induced-consumption spending: changes in consumption spending resulting from fiscal policy. government purchase. You can see how this works in the Multiplier Game of Figure 8-1. Suppose government spends $100,000 on red tape (they really use it!). This initial increase in aggregate demand creates $100,000 more income for workers and firms in the red-tape business. What do these folks do with $100,000 more income? The Marginal Propensity to Consume (introduced in Chapter 6) describes how consumption spending changes when income is altered. If the MPC is 60 percent, for example, $60,000 of the additional $100,000 goes to consumption spending (the other $40,000 is saved). Government spending of $100,000 generates induced-consumption expenditures of $60,000. Does the chain end here? No! The $60,000 spent by red-tape workers creates $60,000 more income for people who produce the cars, furniture, and clothing they buy. These folks use the extra $60,000 to spend FIGURE 8-1 THE MULTIPLIER GAME.
eBook - ePubThe Economics of John Maynard Keynes
The Theory of a Monetary Economy
- Dudley Dillard(Author)
- 2018(Publication Date)
- Papamoa Press(Publisher)
THE ULTIMATE purpose of Keynes’ theory is to explain what determines the volume of employment. The starting point is the principle of effective demand, which states that employment depends on the sum of consumption expenditures and investment expenditures. Consumption depends on the size of consumers’ net income and the propensity to consume, and investment depends on the marginal efficiency of capital taken in conjunction with the rate of interest. A high propensity to consume is favorable to employment, and one of the remedies for unemployment is to be found in measures designed to increase the propensity to consume. When investment increases and causes income to rise, the resulting additions to income are expended largely for consumption. The relationship between increases in investment and increases in consumption, which was discussed in a preliminary fashion in Chapter 3, is explored more fully in the present chapter in terms of the investment multiplier, which is the ratio of an increase of income to a given increase in new investment. In common-sense terms, the investment multiplier means that when investment increases, national income will increase not only by the amount of investment but by some multiple of it. The great practical significance of the multiplier arises in relation to Keynes’ advocacy of public investment and other forms of governmental expenditure as a source of effective demand in periods in which private enterprise does not furnish adequate investment to provide full employment of labor and other resources.The Concept of the Propensity to Consume
The propensity to consume, which is simply the relationship between income and consumption, may be represented by means of a diagram. If values for income (Y) are plotted along the horizontal axis and consumption (C) along the vertical axis, the line which relates these two variables represents the schedule of the propensity to consume, or what is called for the sake of brevity, the propensity to consume. This schedule of the propensity to consume may also be referred to as the “consumption function” because it shows the functional relationship between the two variables, income and consumption. “Propensity to consume” does not mean a mere desire to consume, but the actual consumption that takes place, or is expected to take place, out of varying amounts of income. In this respect it is similar to a demand schedule, which refers not to mere desire to buy but to willingness plus ability to buy. The data on income and consumption in a schedule of the propensity to consume may he either for the community as a whole or for an individual consuming unit. In Keynes’ analysis of aggregates, as previously indicated, it is the national income and national consumption that are significant. When used without qualification, “propensity to consume” or “consumption function” will mean the community or aggregate concept, and in other cases the adjective “family” or “individual” will be used.
eBook - PDF- John E. Marthinsen(Author)
- 2020(Publication Date)
- De Gruyter(Publisher)
For instance, it is possible for government expenditures to encourage gross private domestic investment if it enlarges mar-kets, opens new business opportunities, and creates favorable expectations. The construction of a new highway may increase service investments along the road, such as gas stations and restaurants, and provide incentives for businesses to lo-cate near communities that can now be accessed more easily. Summary of the Fiscal Multiplier Figure 13.3 captures the effect that government borrowing-and-spending have on a nation ’ s real GDP and GDP Price Index. In the absence of any fiscal multi-plier, aggregate demand increases from AD 1 to AD 2 . The fiscal multiplier, with-out any weakening effects, increases aggregate demand from AD 2 to AD 3 , but once the weakening forces are considered, aggregate demand falls from AD 3 to AD 4 . The net result is an increase in aggregate demand from AD 1 to AD 4 . Government Surpluses Surpluses occur when governments spend less than they receive in tax reve-nues and fees. Commonly, surpluses are thought to be contractionary because Government Surpluses 377 falling government expenditures and rising taxes reduce aggregate demand. Therefore, when taxes exceed spending, the government is often viewed as tak-ing more away from aggregate demand than it contributes. As was the case with government budget deficits, economic forces in the three principal macroeconomic markets react to mitigate (but not completely offset) the contractionary impact of these surpluses. In the real goods and serv-ices market, as real GDP falls, tax revenues fall, government transfers rise, and imports fall. In the real credit market, the surplus increases the supply of real credit, thereby reducing the real interest rate and stimulating consumption and investment spending (see Figure 13.4).
eBook - PDFEconomics
Theory and Practice
- Patrick J. Welch, Gerry F. Welch(Authors)
- 2016(Publication Date)
- Wiley(Publisher)
The multiplier effect also applies when nonincome‐determined expenditures are cut back. For example, a decrease in investment spending of $10,000,000, by the time it works its way through the economy, will cause the level of economic activity to decline by more than the initial $10,000,000 decrease. The multiplier effect is frequently used in local impact studies. Sometimes col- leges and universities, for example, will conduct economic studies and use a local multiplier to show how they bring positive economic benefits to a community. Students can be regarded as bringing injections into a local economy as they buy courses, hous- ing, food, books, and such. In addition, multipliers are used to justify large public projects like stadiums. The case is frequently made that a new stadium brings more fans into an area, becomes a tourist magnet, encourages spending for hotels and food, and thus creates additional employment and income for the area. In summary, changes in nonincome‐determined spending, such as investment spending, government and foreign purchases, and household expenditures from transfer payments or borrowing, will cause changes in economic activity that are a multiple of the initial change in spending. Application 5.3, “Ripples through the Economy,” provides three examples of the multiplier effect. The first deals with slumps experienced in western Pennsylvania because of coal and steel, the second with rewards from attracting conventions and sporting events to a city, and the third with recent problems in the auto industry. Keep in mind that the multiplier effect applies to both increases and decreases in spending. 7 Be careful when calculating the multiplier effect to always express the percentage of additional income not spent as a decimal. That is, if 20 percent of additional income is not spent, then the multiplier effect is determined by dividing the initial change in nonincome‐determined spending by 0.20, not by 20.
- Alvaro Cencini(Author)
- 2013(Publication Date)
- Bloomsbury Academic(Publisher)
A mere arithmetic multiplier, is tautological. 18 Shall we then share Haberler's drastic judgement and conclude that Keynes's approach to the multiplier is inadequate and fruitless? We have now to ask, what is gained by this procedure? In reality nothing more than that a new name is given to the multiplier. The multiplier is defined in terms of marginal propensity to consume. Instead of the multi-plier we can always say and for marginal propensity to consume we can always substitute 1 — (1/fc). One and the same thing has got two names. Now, I do not question that sometimes it may serve a useful purpose to have two names for the same thing, but it seems that Mr. Keynes has fallen into the trap of treating such a relationship by definition as a causal or empirical relationship between investment and income and that thereby a large part of what he says about the multiplier and its probable magnitude is vitiated. By assuming something about the marginal propensity to consume he assumes something about the multiplier, but this is no more an explanation of the multiplier than pauvrete is an ex-planation of poverty. 19 If by multiplier we mean a functional relation between in-come expenditure and income earning, such that an initial injection will be followed by a finite chain of induced incomes, it is certainly true that Keynes's definition of the marginal propensity to consume does not support the concept in any decisive way. Yet, this obviously does not imply the falsity of Keynes's point of view. On the contrary, the arithmetical multi-plier seems the only logical way of avoiding a contradiction THE MULTIPLIER ANALYSIS 79 between the necessary equalities I = S, Y = C + /, total supply = total, demand, and the psychological law represented by the marginal propensity to consume. Before reaching any conclusion, let us analyse the last para-graph of this section's initial extract from Keynes.
eBook - PDF- Martha L. Olney(Author)
- 2011(Publication Date)
- Wiley(Publisher)
So dispos- able income goes up by $1,000 million−$250 million = $750 million. The change in disposable income, $750 million, is smaller than the change in income, $1,000 million. To see the effect on equilibrium GDP, assume that the marginal propensity to consume equals 0.8. If taxes were lump-sum and not proportional to income, the multiplier would equal 5. An initial increase in aggregate demand and income of $1,000 million will produce a total change in real GDP that is 5 times as large: $5,000 million. But with a proportional tax rate of 0.25 and an mpc of 0.8, the multiplier equals just 2.5. (See Chapter 8, multiplier with proportional taxes.) An initial increase in aggregate demand and income of $1,000 million will produce a total change in real GDP that is just 2.5 times as large: $2,500 million. Because the swings in real GDP are smaller with proportional taxes than they are without proportional taxes, economists say the economy is more stable with proportional taxes. This is the sense in which proportional taxes are automatic stabilizers. TIP It’s easy to get confused. The example we just did compared the government spending multiplier in a world with lump-sum taxes with the government spending Deficit and Debt 175 multiplier in a world with proportional taxes. That’s different from what we did in the previous section when we looked at the Tax Multiplier, which examines the effect of changing the size of lump-sum taxes. What happens when we start with an initial decrease in aggregate spending? Again, a proportional tax acts as an automatic stabilizer. When there is an initial drop in aggregate spending, output and income fall. Those families whose income has fallen will see a drop in their disposable income. But—the key difference—because taxes are proportional to income, their tax bill drops when their income drops. And therefore the drop in disposable income is smaller than the drop in income.
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