Question

Consider the simple spending multiplier where there are no taxes. This multiplier:

a. is less than 1

b. is smaller than the tax multiplier in absolute value

c. is greater than 1

d. is equal to 1

Answer 1

A simple spending multiplier without taxes is given by

Multiplier = 1/(1 – c); where c is marginal propensity to consume 0<c<1

In case the taxes are given as exogenous then the multiplier becomes = c/(1 – c)

In case the taxes are given as function of income then the multiplier becomes = 1/[1 – c(1 – t)] where t is the tax rate.

From the above one can see that the presence of taxes reduces the value of the multiplier. So, the simple multiplier where there are no taxes is greater than 1.