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...

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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pohnpei397's profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted on

In terms of the consumption function, a permanent tax cut is likely to lead to people having a higher marginal propensity to consume than a temporary tax cut will.

The reason for this is that people will be able to count on having the tax cut continue for a long time.  They will know that the money is going to keep coming so they will be able to plan ahead.

If the tax cut is temporary, people won't know if it will last.  So they're more likely to save the money rather than spending it.  This lowers the MPC.

krishna-agrawala's profile pic

krishna-agrawala | College Teacher | (Level 3) Valedictorian

Posted on

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.

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