Suppose that the government is considering two tax cuts, one temporary and one permanent. Each cut will give each taxpayer the same amount in the first year. The permanent-income hypothesis predicts that:
A) each tax cut will lead to the same amount of consumption in the first year.
B) the temporary tax cut will lead to more extra consumption in the first year.
C) the permanent tax cut will lead to more extra consumption in the first year.
D) the temporary tax cut will lead to no extra consumption at all in the first year.

Question

Quizplus · Accepted Answer

The permanent-income hypothesis suggests that individuals base their consumption on their long-term income expectations. Therefore, a permanent tax cut, which increases long-term disposable income, is likely to lead to more extra consumption in the first year compared to a temporary tax cut, which is seen as a short-term increase in income.

Suppose That the Government Is Considering Two Tax Cuts, One