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Explain why permanent tax cuts are likely to lead to bigger increases in consumer spending then temporary tax cuts do. if you can, try to explain a little in terms of the consumption function as this question was posed in that chapter.

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Lynnette Wofford eNotes educator | Certified Educator

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The "Keynesian consumption function" is an effort to quantify people's spending habits in relationship to GDP. It assumes that as GDP increases, people will have and thus spend more money. The amount of money people spend above that for necessities ("autonomous consumption") is a function of both their disposable income and the amount they tend to save. In theory, a tax cut will increase disposable income, and thus directly increase the ability of consumers to spend money. However, if the tax cut is only temporary, people might decide to save rather than spend the extra money, and therefore a short term tax cut could be ineffective as a stimulus to spending.

The next important factor has to do with the beneficiaries of the tax cut and the state of...

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pohnpei397 eNotes educator | Certified Educator

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krishna-agrawala | Student

I am not sure if there is a clear distinction about temporary and permanent tax cuts. But one thing is clear that permanent tax cuts mus last longer than the temporary one. Thus the permanent tax cuts lead to in reduced tax and higher disposable income for a longer period, leading to greater total increase in spending over a period.

Permanent tax cut may also mean that the government announces in advance that the tax cuts will be continued or even increased for multiple budget periods (usually years). In this case there further increase in spending by individuals in expectation of continued availability of greater disposable income. People do tend to save more when they are uncertain about their future prospect. They are likely to be less concerned about saving for future - or the so called "rainy day" - when they believe that they will have sufficient income in future also. Thus permanent tax cut may further increase the percentage of amount consumed.