Question

In: Economics

In your opinion, which do you think is a better expansionary fiscal approach: cutting taxes or...

In your opinion, which do you think is a better expansionary fiscal approach: cutting taxes or increasing spending? Give the pros and cons of your stance.

Solutions

Expert Solution

Expansionary fiscal policy. This involves the government seeking to increase aggregate demand – through higher government spending and/or lower tax.

If the government cut income tax, then this will increase the disposable income of consumers and enable them to increase spending. Higher consumption will increase aggregate demand and this should lead to higher economic growth.

Alternatively, if the government increased investment in public work schemes, this government spending would create jobs, increase incomes and lead to greater aggregate demand.

This injection of money into the economy can also cause a positive multiplier effect. For example, builders who gain a job will also spend more creating jobs elsewhere in the economy. From the government’s initial injection the final increase in real GDP will be more than the initial investment.

But the fact is that if the government increase spending than reducing taxes , then the multiplier effect will be more in government spending as compared to reduction in taxes .

If the government increases spending than multiplier will be ( 1 / 1- MPC ) , if the govrnment reduces taxes , then multiplier will be ( 1/ 1-c + ct) , where t = marginal propensity to tax .

Hence in the government spending , there is larger multiplier effect than taxes , means that if the government spending is there , there will be more GDP due to larger multiplier effect .

Hence , Government spending is a better fiscal approach.


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