Year Consumption Disposable Spending Income (DI) 1991 1,200 1,500 1992 1,440 1,8
ID: 1225181 • Letter: Y
Question
Year Consumption Disposable
Spending Income (DI)
1991 1,200 1,500
1992 1,440 1,800
1993 1,680 2,100
1994 1,920 2,400
1995 2,160 2,700
In 1995, several tax bills were debated in Congress that would have provided greater tax incentives for saving. (None were enacted.) If such saving incentives had been enacted, and had been successful, how would the consumption function have shifted?
Explain why permanent tax cuts are likely to lead to bigger increases in consumer spending than are temporary tax cuts
Explanation / Answer
a. Had the tax incentives on savings been enacted and had been successful, then the people would have more economic incentive to save than to consume. And if the savings would increase, the level of consumption would reduce. Hence the consumption function would decrease and shift downwards.
b. With a temporary tax cuts, people know that the tax rates would be restored to their original level soon in the near future. So the people tend to save those tax cuts which then be used when the tax rates are back to their original level. Now with permanent tax cut, people have more disposable income in hand to consume without worrying about the restoration of the tax rates. And therefore the consumption increases with a permanent change.
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