Transcript Fiscal Policy

Fiscal Policy and Multiplier
Chapter 11 and 9
4/1/2016
© 2002 Claudia Garcia-Szekely
1
C = 9,100
I = 1000
AE = 10,900
G=
500
NX=
300
Y = 5,000
Y = 10,000
Real Income = Real GDP = Y
Y = 19,000
AE = 24,400
G=
500
I = 1000
AE = 19,000I = 1000
C = 100 + 0.9Y
C = 22,600
C = 17,200
I = 1000
AE = 10,900
G=
500
If C, I, G or NX
increase
C = 9,100
If C, I, G or NX drop
I = 1000
AE = 6,400
G=
500
NX=
300
NX=
300
G=
500
NX=
300
The AE line shifts down
C = 4600
G=
500
I = 1000
NX=
300
NX=
300
The AE line shifts up
AE
Y = 25,000
AE
Equilibrium
If AE line
shifts down
Y > AE
Inventories
increase
Firms
decrease
output
Lower Y*
Equilibrium
output
decreases
AE
New
Equilibrium
Equilibrium
If AE line
shifts up
Equilibrium
output
increase
Firms
Increase
Output
Y*
AE>Y
Inventories
Decrease
Higher Y*
Potential GDP
AE
450
Where we want to
be: zero cyclical
unemployment, no
excess capacity
AE
Equilibrium
GDP: where the
economy is
stuck
Equilibrium GDP
Potential GDP
To increase
To eliminate a
AE, we need
recessionary gap, AE
an increase in
must rise.
C, I, G or NX
Recessionary gap: when
actual
GDP is
than
Economy
is lower
producing
full
less employment
than desired GDP
output
E
B
Distance E-B
Recessionary Gap
7,000-6,000 =1,000
Increase AE to Eliminate a
Recessionary/Deflationary Gap
• To increase Consumption: Decrease
taxes or increase transfers.
• To increase Investment
– Tax incentives.
– Lower interest rates
• Increase Government Spending
• To increase Exports and decrease
Imports: Make dollar weaker
(increasing supply of dollars)
Potential
GDP
S
Increase AE
E
B
Increase AD
D
2,000 3,000 4,000 5,000 6,000 7,000
Real GDP
(billions of dollars per year)
Is the government
concerned with
Decrease Taxes
inflation? Or unemployment?
Increase Transfers
To close the gap we need to increase? Or
Increase
Government
Decrease
AE? andSpending
AD?
To eliminate
To decrease
an
AE,
we need a
inflationary
decrease
in C,
gap,
AE must
I, Gfall.
or NX
Labor
shortages:
Inflationary
gapFirms
when
trying
to hire workers
Equilibrium
GDP is
who
already
have
higher
than
Fulla
job GDP
Employment
= 7,000-8,000 =-1,000
Decrease AE to o Eliminate an
Inflationary Gap
• Decrease Consumption: increase taxes or
decrease in transfers.
• Decrease Government Spending
• Increase interest rates
• Decrease exports and increase imports:
stronger dollar.
Decrease AE
Decrease AD
Is the government concerned with
inflation? Or unemployment?
Increase Taxes
Decrease
Transfers
To close
the gap
we need to
DecreaseOrGovernment
Spending
increase?
Decrease AE?
and AD?
Fiscal Policy
Changes in Government Spending, Transfers
and/or Taxes.
Induce a change in Aggregate Spending.
Increase AE
Decrease AE
Expansionary Policy
Decrease Taxes
Increase Transfers
Increase Government Spending
Contractionary Policy
Increase Taxes
Decrease Transfers
Decrease Government Spending
Assume the Economy is at Equilibrium
1. GDP = ?
2. Is total spending larger than/smaller than/equal to Output?
3. Do Inventories fall, rise or remain unchanged?
4. Does the economy experience a recessionary/inflationary gap?
5. What is the size of the gap?
6. How can the gap be closed?
Assume the Economy
is at Equilibrium
1. GDP = ?
2. Is total spending larger than/smaller than/equal to Output?
3. Do Inventories fall, rise or remain unchanged?
4. Does the economy experience a recessionary/inflationary gap?
5. What is the size of the gap?
6. How can the gap be closed?
Potential
GDP
C+I+G+NX
1.1.
2.2.
3.3.
4.4.
5.5.
6.
6.6.
theeconomy
economyat
atequilibrium
equilibrium??
IsIsthe
TotalSpending(
Spending(>>==<<)Output
)Output
Total
Inventories(rise,
(rise,fall,
fall,remain
remainthe
thesame)
same)
Inventories
Firmswill
will(increase,
(increase,decrease,
decrease,not
notchange)output.
change)output.
Firms
Oncethe
Does
the
theEconomy
economy
Economyreaches
experience
reachesequilibrium,
equilibrium,
a (recessionary,
willthe
the
inflationary)
economyexperience
experience
gap?
Once
will
economy
aa
(recessionary,
Is
the economy
inflationary)
experiencing
gap?
unemployment or labor shortages?
(recessionary,
inflationary)
gap?
theeconomy
economyexperiencing
experiencingunemployment
unemploymentor
orlabor
laborshortages?
shortages?
IsIsthe
Which AE line will cause a
recessionary gap?
Which AE line will cause an
Inflationary gap?
= DY*MPC
Using the MPC =DC
DC/DY
DC = DY*MPC
DC = 1000*0.7
2250+700 = 2950
?
DC = 700
MPC =0.7
2250
a*
DY = 1000
1000
18
2000
The Multiplier
AE1=Y1
DAE
Dc = 81*0.9
Dc = 90*0.9
81
Newly employed buy more
Dc
= and
100*MPC
90services
goods
DG=100
Inventories
Drop
AE0=Y0
45
Sum DC
DG
DY == DAE
DG + sum Dc
DY
DY=100
DY=90
Y0
DY=81
DY=73
DY=66
DY=59
Y1= Y0+DG +sum Dc
Y
We can write the change in
spending as:
100
100 * 0.9
100
100 ** 0.9
0.9 *0.9
*0.9 *0.9
100
100 * 0.9 *0.9
100 * 0.9 *0.9 *0.9 *0.9
100
and so on…
For any increase in autonomous
Factor
out
100:
spending and any MPC:
100
100
100 * 0.9
100 * 0.9 *0.9 *0.9
100 * 0.9 *0.9
100 * 0.9 *0.9 *0.9 *0.9
The Multiplier
45
DAE
AE1=Y1
AE0=Y0
DY = DG (multiplier)
Y
Y0
Y1= Y0+DY
AE1=C+I+G1+NX
AE0=C+I+G0+NX
DY = DG x
AE1=C+I+G1+NX
AE0=C+I+G0+NX
DY =
DY =
[
[
x
]
1
(1- MPC)
1
]
(1- 0.9)
(1/0.1) = 7000
A
increase in government spending
generates a
increase in output.
The shift in
output:
is the same as the increase in Equilibrium
AE1=C+I+G1+NX
AE0=C+I+G0+NX
AE1=C+I+G1+NX
AE0=C+I+G0+NX
An Increase in Government Spending
If
government
Spending
increase by
AE1
45
Increase in
Equilibrium Income:
AE line Shifts up
by
=
AE0
Fixed Taxes (Lump Sum)
Do not change with income:
Residential Property Taxes
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© 2002 Claudia Garcia-Szekely
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The effect of a tax cut
When Taxes
Decrease by
A decrease in Taxes
AE1
45
Increase in
Equilibrium Income:
(-
=
AE0
P0
P0
The Tax Multiplier
D Y = DC x
DC=-DT(MPC)
D Y = -DT(MPC) x
D Y = DT
[
[
[
1
(1- MPC)
]
1
(1- MPC)
- (MPC)
(1- MPC)
]
]
31
The Tax Multiplier
D Y = DT
D Y = DT
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[
- (MPC)
(1- MPC)
[-
]
(MPC)
(MPS)
© 2002 Claudia Garcia-Szekely
]
32
The Tax Multiplier Formula
D Y = DT
A negative
Number!
[
- (MPC)
(1- MPC)
]
Taxes and
Output move in
opposite
directions
Fiscal Policy Multipliers
Smaller
D Y = DG
D Y = DT
Negative
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1
(MPS)
[+
[-
]
(MPC)
(MPS)
© 2002 Claudia Garcia-Szekely
]
34
The Balanced Budget
Multiplier
Captures the effect on equilibrium output from
simultaneous identical changes in Taxes and
Government Spending
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The Balanced Budget
Multiplier is ONE
If DG = DT = 40
DY = 40 (1)
If DG = DT = 100
DY = 100 (1)
If DG = DT = -100
DY = -100 (1)
37
Changes in Budget Deficit
D Deficit = DG (Increase in G,
increases Deficit)
D Deficit = -DT (Increase in T,
decreases Deficit)
Since DG = DT
D Deficit = 0
Output increases by Full Multiplier
Amount
Price level
AD Shifts by the full multiplier amount
DY = DG (1/1-MPC)
P0
Excess Demand: AE > Y,
inventories drop.
If there is excess capacity
and Unemployment,
firms increase output but
AS0
DO NOT raise prices
DY = DG (1/1-MPC)
AD1
AD0
Y0
Real GDP
Y2
Inflation Reduces the Size of the
Multiplier
AS1
Price level
P1
P0
DDYY == D
DG
G (1/1-MPC)
(1/1-MPC)
Excess Demand: AE > Y,
inventories drop.
With some excess
capacity and lower
unemployment, firms
increase both
production and prices.
AD1
AD0
Y0
Y1
Y2
Output increase by
less than the
multiplier amount
Real GDP
At Full Employment there is
NO multiplier effect
AS1
Excess Demand: AE > Y,
inventories drop. With
NO excess capacity and
zero unemployment,
firms cannot increase
production, only prices
rise.
AD
Price level
P1
P0
G (1/1-MPC)
DDYY== DG
(1/1-MPC)
1
AD0
Y0
Real GDP
Effect of Expansionary Policy
Only Prices
rise
At Full Employment
Closer to Full Employment
Prices Increase
Prices do
Not change
Below full employment
Output Increases
by full multiplier
Output
Output
can
Increases
not increase
by
noless
multiplier
than multiplier
effect
Smallest
multiplier
effect
Largest
multiplier
effect
Which segment has the smallest/largest multiplier effect?
The economy must be
operating in segment:
a.A - B
b.B – D
c.D – G
d.None of the above
AThe
50
billion
increase
in G
resulted
inG aisrose
400
increase
inprices.
output the
After
a50After
40
billion
increase
in
G
,
inflation
and
output
remained
main
effect
of
an
increase
in
an
increase
in
aLabor
10
billion
decrease
in
T,
output
increased
by
70b
AAfter
billion
increase
costs
are
in
G
rising
resulted
due
to
in
labor
a
500
shortages.
increase
in
output
An
increase
in
investment
has
the
largest
multiplier
effect.
a 10 billion decrease in T, output increased by 90b
same
Stimulus
Package =
700 Billion
"We're going to be putting money in people's pockets so that they can
spend on buying a new computer for their kid's school, so that they
can, you know, make sure that they are able to deal with heat and
groceries and all the other strains on the family budget,“
President elect, Obama.
46
The American Recovery and
Reinvestment Act of 2009
$787.2 billion stimulus plan: the largest fiscal
injection in history
– $308 billion in discretionary spending
– $288 billion in tax credits and incentives for
individuals and
– $192 billion in direct aid to states,
unemployed and for the adoption of health care
Information Technology
47
Permanent Tax Cut or Tax
Holiday?
• A tax cut has more potential impact in the long
run than a tax holiday.
– A payroll tax credit would provide more of a spending
boost since it is a permanent change in the tax code
• Households are more likely to spend a tax cut if it
is the result of a permanent change rather than a
temporary one
• Households are more likely to save a temporary
tax cut.
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© 2002 Claudia Garcia-Szekely
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Tax Cuts Benefit the Rich more
than the Poor
A tax cut on:
Income: benefits high income earners more than low
income earners
Savings: benefits high income earners who do most
of the personal saving
Capital Formation (investment) tend to benefit those
with the means to accumulate capital
Capital Gains: Tend to benefit more those with larger
financial assets.
49
AUTOMATIC STABILIZERS
Make Disposable Income and
Consumer spending less sensitive to
fluctuations in GDP
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© 2002 Claudia Garcia-Szekely
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1. Personal Income Taxes
• When GDP rises, we earn more income and
pay more taxes: consumption does not rise
as much as it would if taxes did not increase
with income.
• When GDP falls, we earn less income and
pay less taxes: consumption does not fall as
much as it would if taxes did not fall with
income.
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2. Unemployment Compensation, Income
Supplements for the poor
• When GDP rises, fewer people receive
unemployment insurance, reducing the rise in
incomes (and consumption) that comes with a
rising GDP.
• When GDP falls, more people receive
unemployment insurance, reducing the fall in
incomes (and consumption) that would occur
with a falling GDP.
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MPC = 0.75. Find DG and DT necessary to
close the gap.
For each, calculate DC, D Deficit.
Potential
GDP
E
S
B
D
2,000 3,000 4,000 5,000 6,000 7,000
Real GDP
(billions of dollars per year)
AE
15,000 20,000
C
Potential
GDP
450
Real Expenditures
(Billions)
AE = 3,000+0.8Y
23,000
19,000
15,000
11,000
7,000
5,000 10,00015,000 20,000 25,000
Real GDP
(Billions)
A
Potential
GDP
450
Real Expenditures
(Billions)
AE = 3,000+0.8Y
23,000
19,000
15,000
11,000
7,000
5,000 10,00015,000 20,000 25,000
Real GDP
(Billions)
B
Potential
GDP
450
Real Expenditures
(Billions)
AE = 2,500+0.9Y
34,000
29,500
25,000
11,000
7,000
15,000 20,000 25,000 30,000 35,000
Real GDP
(Billions)
MPC = 0.75
Calculate the effect on equilibrium output:
1. Government Spending decreases by 100b
2. Investment increases by 50b
3. Autonomous Consumption drops by 70b
4. Taxes increase by 100b
5. A simultaneous increase in government
spending and taxes of 50b
6. Net Exports increase by 40b
7. An 80b increase in transfers.
8. A simultaneous increase in government
spending and a decrease in taxes of 50b
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9. If the multiplier is 2.5 what is the MPC?
10. What is the necessary change in government
spending in order to close a 1,000b recessionary
gap?
11. What is the necessary change in taxes in order
to close a 1,000b recessionary gap?
12. Calculate the necessary change in government
spending and taxes to close a 1,000
recessionary gap?
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13. A 50b increase in government spending
resulted in a 125b increase in equilibrium
output. What is the size of the multiplier?
What is the MPC? What is the MPS?
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700 B in Government Spending
Become 700B increase in
income
To calculate Induced
Consumption Spending:
DC = DY*MPC
DC = DY*0.9
DC =700*0.9 = 630
700 in income, generate 630 in
additional consumer
spending
4/1/2016
Become 700B increase in
income
To calculate induced savings
DS = DY*MPS
DS = DY*0.1
DS =700*0.1
700 in income, generate 70 in
additional saving
© 2002 Claudia Garcia-Szekely
62
45
AE1
AE0
DC=DY*MPC
DC=700*0.9
DC= 630
DAE =700
DG =70
DG =70
DY = 700
DY = DG(Multiplier)
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450
DC =630*0.9
DC =567
DC =63
63
DY = 630
DY = 63(10)
64
DAE =630
Round #
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Change in
Spending
700
630
567
510
459
413
372
335
301
271
244
220
198
178
160
144
130
117
105
95
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Change in
Income
700
630
567
510
459
413
372
335
301
271
244
220
198
178
160
144
130
117
105
95
Change in Induced
Consumption =DY*MPC
Change in
Saving=DY*MPS
630
567
510
459
413
372
335
301
After
40
After
After271
20
100rounds
rounds
roundsof
ofof
244
the
multiplier
the
the
multiplier
multiplier
220
process,
AE
process,
process,
AEhave
have
have
198 AE
increased
178 by
increased
increased
by
by6,897
6,149
7,000
160
billion!
billion!
billion!
144
130
117
105
95
85
© 2002 Claudia Garcia-Szekely
70
63
57
51
46
41
37
33
30
27
24
22
20
18
16
14
13
12
11
9
65
1/(1-MPC) = 2.5
1/MPS = 2.5
1/ 2.5 = MPS
0.4 = MPS
0.6 = MPC
The policy multiplier
is the cumulative
impact on GDP over
several quarters
Government
estimates the
multiplier to be
between 1 and 2.5
4/1/2016
If they estimate the
multiplier to be 2.5
what is their
estimate of the
MPC?
© 2002 Claudia Garcia-Szekely
66
Output
10,000
15,000
20,000
25,000
30,000
35,000
40,000
Consumption Investment
10000
14500
19000
23500
28000
32500
37000
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500
500
500
500
500
500
500
Government
Spending
Net
Exports
300
300
300
300
300
300
300
200
200
200
200
200
200
200
© 2002 Claudia Garcia-Szekely
67
Use the table above to answer the following:
1. Calculate Aggregate Expenditures (add a column to
the table for AE).
Calculate the slope of the AE line (=MPC).
Calculate the intercept of the AE line (=a +I+G+NX)
2. Find the equilibrium value of output.
3. Use the multiplier formula to calculate the new
equilibrium value of income that results when
Investment increases by 200.
What is the size of the shift in the AE line? Draw the
AE – 45 degree diagram to show the original and
the new equilibrium values of income.
What is the size of the shift in the AD line? Draw the
AD line to show the change in AD.
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4. Starting from the original equilibrium where I=
500, calculate the new equilibrium value of
income that results when autonomous
consumption decreases by 300.
What is the size of the shift in the AE line?
Draw the AE – 45 degree diagram to show the
original and the new equilibrium values of income.
What is the size of the shift in the AD line? Draw
the AD line to show the change in AD.
5. Suppose that output is NOT the equilibrium value
but Y = 30,000. Calculate the change in
inventories. Do firms have an incentive to
produce more, less or the same output level?
Why?
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6. Suppose that output is NOT the
equilibrium value but Y = 15,000.
Calculate the change in inventories. Do
firms have an incentive to produce more,
less or the same output level? Why?
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7. Consider the following equations for a
simple economy without government or
foreign sector:
C = 500 +0.9Y
I = 700
G= 500
NX = 200
a. Calculate the equilibrium output level
b. Calculate the value of consumption at
equilibrium.
c. Calculate Aggregate Expenditures at
equilibrium.
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8. We observed that when investment increased
by 50, the equilibrium value of output
increased by 250. Given that information,
what is the value of the multiplier? What is
the value of the MPC? What is the value of
the MPS?
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The effect of an increase in Investment = 50.
MPC= 0.8
D Y = DI x
[
D Y = 50 x
[
1
(1- MPC)
1
(1- 0.8)
]
]
D Y = 50 (1/0.2) = 250
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Change in
Investment =50
MPC = 0.8
Round #
Change in
Spending
1
50
50
Change in Income
Change in Induced
Consumption
Change in
Saving
50
50
40
40
10
10
32
8
25.6
6.4
40 50 in capital 40
•Firms2 spend an extra
goods
3
32
32
•Manufacturers
were
not expecting
this increase 20.48
4
25.6
25.6
5.12
5
20.48
20.48
16.384
4.096
6
16.384
16.384
13.1072
3.2768
7
13.1072
13.1072
10.48576
2.62144
8
10.48576
10.48576
8.388608
2.097152
9 incomes
8.388608
•Increase
= 50
8.388608
6.7108864
1.677722
6.7108864
5.36870912
1.342177
•Inventories drop
•Increase output (employment)
10
6.7108864
5.36870912
4.294967296
•Since11incomes5.36870912
increase, Consumption
increases
by DY x MPC =1.073742
50 x
0.8=40
12
4.2949673
4.2949673
3.435973837
0.858993
13
3.43597384
•The 14
rest (10) is2.74877907
saved
3.43597384
2.748779069
0.687195
2.74877907
2.199023256
0.549756
Change in
Investment =50
MPC = 0.8
Round #
1
2
Change in
Spending
50
40
40
Change in Income
Change in Induced
Consumption
Change in
Saving
50
40
40
40
32
32
10
88
3
32 extra 40 in consumer
32
•Consumers
spend an
goods 25.6
4
25.6
25.6
•Manufacturers
were
not expecting
this increase 20.48
•Inventories
drop 20.48
5
20.48
16.384
•Increase
6 output (employment)
16.384
16.384
13.1072
7
13.1072
•Increase
incomes
= 40
8
10.48576
6.4
5.12
4.096
3.2768
13.1072
10.48576
2.62144
10.48576
8.388608
2.097152
9
8.388608
8.388608
6.7108864
1.677722
11
5.36870912
5.36870912
4.294967296
1.073742
4.2949673
•The 12
rest (8) is saved
4.2949673
3.435973837
0.858993
•Since incomes increase, Consumption increases by DY x MPC = 40 x
10
6.7108864
6.7108864
5.36870912
1.342177
0.8=32
13
3.43597384
3.43597384
2.748779069
0.687195
14
2.74877907
2.74877907
2.199023256
0.549756
Change in
Investment =50
MPC = 0.8
Round #
Change in
Spending
Change in Income
Change in Induced
Consumption
Change in
Saving
1
50
50
40
10
2
40
40
32
8
3
32
32
25.6
6.4
4
25.6
25.6
20.48
5.12
5
20.48
20.48
16.384
4.096
6
16.384
16.384
13.1072
3.2768
7
13.1072
13.1072
10.48576
2.62144
8
10.48576
10.48576
8.388608
2.097152
9
8.388608
8.388608
6.7108864
1.677722
10
6.7108864
6.7108864
5.36870912
1.342177
11
5.36870912
5.36870912
4.294967296
1.073742
12
4.2949673
4.2949673
3.435973837
0.858993
13
3.43597384
3.43597384
2.748779069
0.687195
14
2.74877907
2.74877907
2.199023256
0.549756
Change in
Multiplier =
1/(1-0.8) = 5
Change
in
Change in
Spending
Equilibrium
Y
1
Spending
50
Change in Income
Income
50
Consumption
40
Saving
10
2
40
40
32
8
3
32
32
25.6
6.4
25.6
25.6
20.48
5.12
20.48
20.48
16.384
4.096
16.384
16.384
13.1072
3.2768
13.1072
13.1072
10.48576
2.62144
10.48576
10.48576
8.388608
2.097152
8.388608
8.388608
6.7108864
1.677722
6.7108864
6.7108864
5.36870912
1.342177
11
5.36870912
5.36870912
4.294967296
1.073742
12
x5
50
250
x5
50
250
(250)x0.8
DY*MPC
200
(250)x0.2
(DY)xMPS
50
Change
in
Change in
4.2949673
4.2949673
3.435973837
0.858993
13
DY=DI*(1/1-MPC)
Round #
Change in
Change in
Induced
Change
in Induced
DY=50+200
DY=DI+DC
MPC = 0.8
Change in
Investment =50
3.43597384
3.43597384
2.748779069
0.687195
14
2.74877907
2.74877907
2.199023256
0.549756
4
5
6
7
8
9
10
Consumption
Saving
Stimulus Package: Spending Portion 317 Billion
dollars
Billions of
Expenditure Category
Dollars
Labor, health
and
education
21%
Energy and
environment
31%
Transportati
on, housing
and urban
development
18%
Federal and
State
Government
14%
Transportation,
housing and urban
development
Federal and State
Governmnet
Comerce Justice and
Science
Defense and security
Agriculture and rural
development
Energy and
environment
Labor, health and
education
Total
Commerce
Justice and
Agriculture Defense and
Science
and rural
security
6%
development
5%
5%
57
45
18
16
16
98
66
317
Allowing tax cuts to expire and
mandated spending cuts to be
implemented.
A high probability of recession (a 1.3%
GDP contraction) during the first half of
the year 2013
Debt: 69% GDP in 2011 to 84% by
2035
Extending the Bush income tax cuts, restricting the
reach of the AMT, and keeping Medicare
reimbursement rates at the current level, versus
declining by one-third as mandated under current
law.
Debt: 69% GDP in 2011
to 100% by 2021 and
approaches 190% by
2035
Sources of Deficit Reduction for 2013
End Payroll
Tax Cut
End Tax
Cuts:
Increase in
ATM
Increase in
revenue
from
economic
Growth
Spending
Cuts
End extension
Unemployment
Insurance
Disc. Spending 2011 total
$1,277 billion:
$712 b for defense
$566 b for non-defense.
Cuts totaling $110 billion per
year will be applied from 2013
to 2022, split evenly ($55
billion each) to defense and
non-defense spending
he Federal Government Dollar:
Where It Comes From
2008
Discretionary
Spending
Mandatory
Spending
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© 2002 Claudia Garcia-Szekely
83
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© 2002 Claudia Garcia-Szekely
84
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85
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© 2002 Claudia Garcia-Szekely
86
Variable taxes T= tY
INCOME TAX: CHANGES WITH
INCOME
Personal Income Taxes
Corporate Income Taxes
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© 2002 Claudia Garcia-Szekely
87
Variable Taxes: tY
Fixed Taxes
C = a + b(Y-T)
Slope
C = a + bY – bT
C and AE
=b
C = (a –bT) + bY
Example: T=700
C = 1000 + 0.9(Y-700)
C = 1000 + 0.9*Y – 0.9*700
C = (1000 –0.9*700) + 0.9*Y
C = (1000 – 630) + 0.9Y
Variable Taxes
T= tY
Slope
C = a + b(Y- tY)
C and AE
= b-bt
C = a + bY-b tY
C = a + (b-bt) Y
Example: T = 0.25Y
C = 1000 + 0.9(Y-0.25Y)
C = 1000 + 0.9Y – 0.9*0.25Y
C = 1000+ Y(0.9-0.9*0.25)
C = 1000 + (0.9-0.225)Y
O.675
slope smaller
88
Variable taxes T=T+ tY
INCOME TAX: CHANGES WITH
INCOME
OTHER TAXES: NOT RELATED TO
INCOME
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89
Variable Taxes: T=T+ tY
Fixed Taxes
C = a + b(Y-T)
Slope
C = a + bY – bT
C and AE
=b
C = (a –bT) + bY
Example: T =700
C = 1000 + 0.9(Y-700)
C = 1000 + 0.9*Y – 0.9*700
C = (1000 –0.9*700) + 0.9*Y
C = (1000 – 630) + 0.9Y
Variable Taxes
T=T+ tY
C = a + b(Y- (T+tY))
Slope
C = a + bY-b(T+tY)
C and AE
C = a + bY-bT-btY
= b-bt
C = (a –bT)+ (b-bt)Y
Example: T = 700+0.25Y
C = 1000 + 0.9(Y-700 -0.25Y)
C = (1000 – 630) + (0.9-0.9*0.25)Y
C = (1000–630) + Y(0.9-0.225)
C = (1000–630) + O.675Y
Intercept same, slope smaller
90
Variable taxes make C and AE
flatter
I+G+N
X+a
a-bT
I+G+NX+
a–bT
a –bT
Steeper
When T Increases: C shifts
down
Smaller slope = flatter
Smaller slope = flatter
t
When Increases: C
becomes flatter
Variable taxes make C and
AE flatter
C
Steeper: increase in C is
larger
DC=100*MPC = 100*0.9 = 90
C
Flatter: increase in C is
smaller
DC=100*(MPC-MPC*t) = 100*(0.9-0.9*0.25)= 67.5
DY=100
Part of the increase in income goes to pay taxes so
consumption does not increase as much.
Variable Taxes(tY) affect the
When t rate
increases, multipliers
multiplier
decreases
Fixed Taxes
D Y = DG
D Y = DT
Variable Taxes
[
1
(1- b)
[
-b
(1- b)
]
]
D Y = DG
D Y = DT
[
[
1
(1-b+bt)
-b
(1-b+bt)
]
]
Both multipliers become smaller
The G multiplier with variable taxes (Income
Tax)
• The effect of an increase in G is smaller with income taxes because
as income increases, the government taxes a portion of the increase
in income.
DY = DG + DC; DC is smaller than before
• The effect of a tax cut is also smaller with income taxes because as
income increases, the government taxes a portion of the increase in
income.
DY = DC; DC is smaller than before
The oversimplified formula overstates the size of the
multiplier