Suppose that the government were to replace the income tax with a consumption tax. What would happen to the interest rate and investment, respectively?
A) increase and increase
B) decrease and decrease
C) increase and decrease
D) decrease and increase

Question

Quizplus · Accepted Answer

If the government replaces the income tax with a consumption tax, disposable income will increase for individuals, leading to an increase in consumption. This increase in consumption will, in turn, increase demand for goods and services, leading to an increase in investment. Therefore, investment will increase. However, this increase in demand will also lead to inflation, prompting the central bank to raise interest rates to control inflation. Thus, the interest rate will decrease, and investment will increase.

Suppose That the Government Were to Replace the Income Tax