The level of crowding out associated with a tax cut will be smaller if the tax change has a supply-side effect than it will be if it only has a demand-side effect.

Question

Quizplus · Accepted Answer

This statement is true. A tax cut that has a supply-side effect, such as a reduction in marginal tax rates that encourages greater work effort and investment, can increase the overall level of economic output and offset some of the decline in government revenue due to lower tax rates. In this case, the crowding out effect (the reduction of private investment due to increased government borrowing) may be smaller than if the tax cut only had a demand-side effect, such as a direct increase in government spending or transfer payments to individuals.

The Level of Crowding Out Associated with a Tax Cut