Description                                  
The narrator examines the effect that taxation has on household income. 

Marge: 
It's a good thing the federal government started that big highway project just across town. That should pump a lot of money into the local economy. It's about time they do something constructive with our tax dollars. But, I still think we'd all be better off if they cut taxes. 

Narrator: 
Marge represents the typical household. She hates paying taxes and she rarely appreciates the goods and services that government provides to society using tax dollars. 

Narrator: 
Households and firms make tax payments to the government. The government spends some of this revenue on goods and services and some of it on transfer payments back to households and firms. 

Narrator: 
Net taxes refers to total tax payments minus the transfer payments that come back to households. Net taxes is the amount of income that households ultimately pay to the government. The income that households retain once net taxes have been paid is after tax income or disposable income. 

Narrator: 
When taxes are assumed to be a fixed amount, independent of income, they are often called lump sum taxes or autonomous taxes. 

Narrator: 
If the government does indeed cut taxes as Marge hopes, one possible goal is to encourage economic expansion by increasing the consumption power of households and firms. 

Narrator: 
To illustrate how a decrease in taxes can result in an increase in consumption, assume for simplicity that taxes are autonomous and that government spending does not change. Suppose the government reduces net taxes by $100 billion-dollars-this increases households' disposable income by $100 billion-dollars. Households save some of this $100 billion and spend the rest according to their marginal propensities to save and consume. This increase in spending increases aggregate income. This results in yet another boost in consumer spending. The process continues with increases in spending becoming smaller and smaller until the effects are negligible. 

Narrator: 
With a marginal propensity to consume of 0.75, the end result of a $100 billion-dollar tax decrease is a $300 billion-dollar increase in aggregate income. This multiplier is known as the autonomous tax multiplier. In this instance, the multiplier is -3, a $100 billion-dollar tax decrease leads to a $300 billion-dollar increase in aggregate income. 

Narrator: 
It is important to note that net tax cuts do not directly increase aggregate expenditure in the way that additional government spending does. An increase in government spending results in an equal and direct increase in aggregate expenditure. However, a change in taxes has no direct impact on aggregate expenditure, it only directly effects disposable income and since a portion of this income is saved, a $100 billion-dollar decrease in taxes raises consumption by only $75 billion-dollars. The remaining $25 billion is saved. 

Narrator: 
Algebraically, the initial effect that a tax decrease has on consumption is the initial change in taxes multiplied by the marginal propensity to consume. The total effect of the tax cut on income is the initial change in consumption times the simple spending multiplier. 

Narrator: 
The autonomous tax multiplier is the total change in aggregate income divided by the net change in taxes. Algebraically, the tax multiplier can be expressed in terms of the marginal propensity to consume. 

Narrator: 
Knowing the MPC, the tax multiplier can be used to compute the impact of any increase or decrease in the tax level. For example, with the MPC equal to 0.75, the tax multiplier is -3. If taxes fall by $100 billion-dollars, aggregate income would rise by $300 billion-dollars. Conversely, if taxes rise by $100 billion, aggregate income would fall by $300 billion. 

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