National Income Multiplier and Income Tax

Readers Question: Explain how a change in the rate of income tax is likely to affect the size of the national income multiplier ?…………..

…..would appreciate if you can give me the main points i should include ..thank you

The National Income Multiplier says that an initial increase in spending can cause further rounds of spending. Therefore, the final increase in National Income is greater than the initial spending (or injection of Money)

e.g if Government increase spending on the wages of nurses by £2billion. That means National Income increases by £2billion. However, if nurses spend part of their extra wages, additional output and incomes will be generated. The final increase in National Income may be £3 billion. Therefore, there is a multiplier effect of 3/2 = 1.5

What Determines size of Multiplier?

• The size of the multiplier depends on withdrawals and the marginal propensity to consume
• If nurses spend 90% of their extra income, the multiplier effect will be high. If they spend only 10% of extra income the multiplier effect will be low.
• A cut in income tax means that people keep a high % of their gross income. Therefore the multiplier effect will be higher. A cut in income tax is a withdrawal – leading to less spending and therefore it reduces the size of the multiplier.
• Multiplier Formula = 1 / 1-mpc
• As income tax increases the marginal propensity to consume will fall.