Question
If the marginal propensity to consume (MPC) is 0.75 and
the tax rate is 0.20, the value of the tax multiplier is:Solution
o Simple Tax Multiplier: The standard formula for the tax multiplier with lump-sum taxes is -MPC/(1-MPC). Here, MPC = 0.75. So, Multiplier = -0.75 / (1 - 0.75) = -0.75 / 0.25 = -3.0. o Complex Multiplier (for reference): If the question specified a proportional income tax, the multiplier would be different: -MPC / [1 - MPC(1-t)]. Plugging in: -0.75 / [1 - 0.75*(1-0.2)] = -0.75 / [1 - 0.75*0.8] = -0.75 / [1 - 0.6] = -0.75 / 0.4 = -1.875. However, the term "tax multiplier" in most standard exam contexts refers to the simple lump-sum version, which yields -3.0.
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