Question

Using the aggregate expenditure and injection-leakage approach, explain the effects of a decrease in proportional tax on equilibrium income.

Answer 1

Proportional tax is a fixed tax with no change if the taxable base amount increases or decrease. Here the marginal tax rate is equal to the average tax rate. Under proportional tax the lower income group people are tend to spend greater amount or percentage of their income than the higher income group people. If the proportional tax will fall down, the consumption pattern of the low income people will increase. Because their level of disposable income will increase with a fall in the tax rate.
The proportional tax does not have adverse effect on incentive of the workers and the saving of tax payers. With the fall in proportional tax rate, the canon equality can be maintained in a lower sense. This will increase the saving rate of low income people. On the other hand, it is a leakage to the government expenditure. With fall in tax rate, the saving rate will increase. This will reduce the amount of money in circulation and the revenue of the government will fall down.