Answer to Question #251102 in Macroeconomics for Ntando

Question

The supply-side effect of fiscal policy shows that an increase in the marginal tax rate on labor income will do the following:

A. Decrease in potential GDP

B. Increases potential GDP because people work more as they have less disposable income

C. Increase the incentive to work

D. Increases the equilibrium quantity of labor as firms demand more workers at the lower wage

Answer 1

Solution:

The correct answer is A. Decrease in potential GDP.

 

As the marginal tax rate rises, the taxpayer ends up with less money per dollar earned than they did previously. Therefore, it will end up reducing the potential GDP through behavioral responses such as decreasing labor supply or national savings.