Policymakers want to collect 10% more in sales tax revenue next year, and so they raise the sales tax rate by 10% from 5% to 5.5%. Which of the following assessments would be consistent with rational expectations? Next year, sales tax revenue will:

Question

Quizplus · Accepted Answer

Raising the sales tax rate from 5% to 5.5% is a 10% increase in the rate itself, but the actual impact on sales tax revenue depends on how consumers respond to the price increase. If consumers reduce their spending due to higher prices, the increase in revenue will be less than 10%. This is consistent with the concept of elasticity of demand, where a price increase can lead to a decrease in the quantity demanded, thus affecting total revenue.

Policymakers Want to Collect 10% More in Sales Tax Revenue