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Tax Multiplier: T-Multiplier (With Diagram)

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We know that a tax increase results in a decline in income. In other words, it is contractionary in effect. An increase in tax (∆T) leads to a decrease in income (∆Y). The ratio of ∆Y/∆T, called the tax multiplier, is designated by KT Thus,

KT = ∆Y/∆T, and ∆Y = KT. ∆T

Again, how much national income would decline following an increase in tax receipt depends on the value of MPC. The formula for KT is

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Thus, tax multiplier is negative and, in absolute terms, one less than government spending multiplier. If MPC = 3/4 then the value of KT = (-3/4)/(1-3/4)= -3.an increase in taxes of Rs. 20 crore results in a decline of income of Rs. 60 crore. That is to

-60 = (-3/4)/(1-3/4)

In contrast, with an MPC = 3/4, the value of KG = 4. Assume an increase in government expenditure of Rs. 20 crore. Applying the formula for KG, we obtain

clip_image004

Thus, KT is negative and its value is one short of K, or KG.

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Graphically, tax multiplier has been shown in Fig. 3.18. Pre-tax consumption line and aggregate demand schedule are represented by C1 and C, + I + G, respectively. The corresponding equilibrium level of income is OYI. An increase in taxes shifts the consum­ption line to C2. Consequently, aggregate demand schedule also shifts downwards to C, + I + G. Consequently, income declines to OY2. Thus, the effect of an increase in taxes on income is contractionary.

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One must know the distinction between KI or KG and KT.This is demonstrated in terms to Table 3.4.

Table 3.4: KI or KG Vs KT

Thus, KT is negative and one less than KI or KG.

The G-multiplier and T-multiplier are also called fiscal multipliers as these multipliers are associated with the fiscal activities of the government (i.e., changes in expenditure and taxation plans).

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