Question

1. What, if anything, should be done about the deficit? Would you increase revenue? If so, what taxes would you adjust? Should expenditures be slashed, what should be decreased? By how much?

2.Which has a larger effect on aggregate demand: an increase in government expenditure or an equal sized decrease in taxes?

Answer 1

Answer 1:

The level of government deficit can be reduced by either reducing the level of government expenditure or by increasing the level of tax revenue of the government. Yes, the government should increase its revenue which can be done by increasing the level of direct taxes mainly income tax rate in the economy because income taxes are more progressive in nature . yes, the government can also reduce its expenditure to reduce the level of budget deficit mainly fiscal expenditure which is unproductive in nature. The amount of decrease depends on the level of budget deficit.

Answer 2:

Increase in government expenditure has a direct impact on the level of aggregate demand in the economy because it impacts aggregate demand directl and thus the impact is larger than equal decrease in tax rate which has an indirect impact on the level of aggregate demand. Because decrease in tax rate will increase disposable income will in turn increases the level of aggregate demand.