Question

Now we introduce the role of income taxes into the Keynesian system. U.S. taxes consist of autonomous taxes and income taxes. Autonomous taxes such as sales taxes and property taxes do not depend on income, whereas income taxes such as personal income taxes and corporate income taxes depend on the level of income. When we introduce income taxes into the model, the multipliers are modified as follows:

Assuming that the U.S. MPC is 0.9, and the average income tax rate is 0.3 (30%), calculate the multipliers

The (autonomous) tax multiplier = -MPC/[1 - MPC(1 - Tax rate)].

Answer 1

MPC = 0.9

Income tax rate (t) = 0.3

Multiplier = 1 / [1-MPC(1-t)]

Multiplier = 1 / [1 - 0.9 (1-0.3)]

Multiplier = 1/ [1 - 0.9 (0.7)]

Multiplier = 1 / [1 - 0.63]

Multiplier = 1 / 0.37

Multiplier = 2.70

Tax multiplier = -MPC / [1 - MPC (1-t)]

Tax multiplier = -0.9 / [1 - 0.9(1-0.3)]

Tax multiplier = -0.9/[1 - 0.9(0.7)]

Tax multiplier = -0.9 / [1 - 0.63]

Tax multiplier = -0.9 / 0.37

Tax multiplier = -2.43