When calculating the effect of a tax cut on equilibrium GDP,the tax multiplier is always
A) 2.0 smaller than the spending multiplier
B) 1.0 smaller than the spending multiplier and negative in sign
C) positive
D) positive and larger than the spending multiplier
E) negative and larger than the spending multiplier

Question

Quizplus · Accepted Answer

The tax multiplier is always smaller than the spending multiplier because each dollar of tax cut does not directly increase spending by the full dollar, as some of the cut may be saved instead of spent. Additionally, the tax multiplier is negative in sign because a tax cut would increase disposable income and therefore consumption, but it would also decrease government revenue, which reduces aggregate demand. Therefore, the tax multiplier is always 1.0 smaller than the spending multiplier and negative in sign.

When Calculating the Effect of a Tax Cut on Equilibrium