Question

If the Government  cut income taxes by 100 billion and the marginal propensity to consume (MPC) is equal to .75? How would this tax cut impact the National Budget and the National Debt? What are the pros and cons of running a deficit? Would you support such a tax cut and for whom should we impose the tax cut?

Answer 1

The tax multiplier is : MPC/(1-MPC)

Here it's ( 0.75/1-0.75) =3

An income tax cut will lead to a generation of 100x3= 300 billion in the GDP.

The national will fall, and this will increase the deficit, thus increasing National Debt if any.

Pro : increased income and consumption, which leads to a greater growth rate in the economy

Cons: National debt increases, so is the cost of debt payment will also increase.

The tax cut can be supported, if the estimated growth rate if greater than rate at which debt is taken. The tax cut should be focused for the lower and middle income group of the economy. As this increased disposable income will lead to greater consumption. If higher income groups are given the benefit of tax cut, the effect of the multiplier will decrease, as the marginal propensity to save is higher for higher income groups.

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