Tax-adjusted multiplier and the balanced budget multiplier, Macroeconomics

The tax-adjusted Multiplier and the balanced budget Multiplier are explained below:

Taxes act as drag on the multiplier effect of government expenditure, because they represent a leakage from the circular flow of incomes. The tax-adjusted multiplier k* is lesser than the basic Keynesian multiplier, k, introduced earlier. k* is given by {1/[1-(MPC)(1-t)]}, where the t is net income tax rate, and becomes T = tY. The higher is the tax rate, the greater is the leakage and the smaller fiscal policy multiplier.

It is interesting to consider special case of the balance budget multiplier. The concept here is that if government expends Rs.10 bn and finances it by raising the value fo taxes by Rs. 10 bn, the multiplier will not be zero, as one may initially expect. This is since, higher tax causes disposable income to fall, which in turn causes the saving and imports (the remaining two types of leakages) to fall. Hence the net leakage from the system is even less than Rs. 10 and there is the positive multiplier effect, albeit small.

Posted Date: 7/19/2012 3:23:51 AM | Location : United States

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