Answer to Question #143070 in Macroeconomics for solomon

Question

6. Assuming a classical model, government decides to increase the marginal income tax rate (PAYE). How would this change affect output, employment, and the price level? In your answer consider two cases, case one in which the increased revenue produced by the tax increase results in a decline in bond sales to the public, and a second case when it results in lower money creation. [10]

Answer 1

If the government decides to increase the marginal income tax rate (PAYE), then in the first case, when the increasing income received as a result of the tax increase, leads to a decrease in bond sales to the population, due to the fact that bonds are bought from the surplus formed by the population. In the second case, when a tax increase leads to a smaller inflow of money, this means that the imposed tax is too large to carry a stimulating function.