Question

the u.s is a large economy with a trade deficit. suppose the us fedral government permanently increase income tax. how will this policy affects the us saving investment, real interest rate and capitall flows? is it possible yo use monetary policy to prevent changes due to this tax policy? if yes how

Answer 1

Permanent increase in the income tax leads to investment and reduce the direct effect on growth. The tax rate affects the savings in a similar way. A lower rate of tax on the capital income like interest or dividend rents other different incomefrom assets encourage extra savings as well as investment by raising return on after tax. If the tax revenues are reduced then deficit is increased.when the income tax increases the demand is increased by the tax cut as disposable income is increased as well as business are encourage to hire and increase their investment. The effects of demand can also be substantial in case of weak economy when the economy is operating near capacity.when Government have increased the income tax there is less availability of income in the household for consumption. Hans tax increase is equal to consumption decrease. Which is followed by increase in investment but for that to happen interest rates need to be decreased.