Fiscal Policy – the Tax Multiplier

This is part two of the lessons on the multiplier effects of fiscal policy. The first lesson explained how the Keynesian Spending Multiplier could be found using the marginal propensities to consume and save. Watch that video here before watching the one below.

This lesson illustrates how a tax cut of a particular amount will ultimately affect aggregate demand in the economy and therefore total output. Tax cuts are an indirect injection into the macro-economy, meaning that they put money into the pockets of households, but who then get to decide how much of it to spend on goods and services. For this reason, the tax multiplier is generally thought to be smaller than the spending multiplier. What does this mean for fiscal policy-makers? When considering the possible expansionary effects of a particular tax cut or government spending package, it should be acknowledged that tax cuts, may not provide the level of stimulus as government spending, since some of a tax cut will be saved rather than spent.

 

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