TAXES & THE MULTIPLIER

TAXES & THE MULTIPLIER - SECTION 20: HOW INCOME TAXES...

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SECTION 20: HOW INCOME TAXES AFFECT THE MULTIPLIER
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HOW DO INCOME TAXES INFLUENCE THE MAGNITUDE OF THE MULTIPLIER? Suppose the mpc = .75 Suppose we consider an economy without taxes. Suppose autonomous spending increases by $100. The successive increases in output will be Round 1: $100 Round 2: $100 x .75 = $75 Round 3: $100 x .75 x .75 = $75 x .75 = $56.25 Round 4: $100 x (.75) 3 = $42.19 Round 5: $100 x (.75) 4 = $31.64 And so forth
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Now consider the same economy with an income tax of, say, 20%. Suppose autonomous spending increases by $100. The successive increases in output will be as follows: Round 1: $100 Because there is a 20% tax, in round 2, the worker who earned $100 only has $80 of disposable income. Given an mpc of .75, the worker spends 75% of the $80. This yields new spending, and new output of $60. Round 2: $100 x (1 - .20) x .75 = $100 x .60 = $60 Round 3: $100 x (1 - .20) x .75 x (1 - .20) x .75 = $100 x (.60) 2 = $36 Round 4: $100 x (.60) 3 = $21.60 Round 5: $100 x (.60) 4 = $12.96
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TAXES & THE MULTIPLIER - SECTION 20: HOW INCOME TAXES...

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