Investment can be increased both by reducing taxes on private saving and by redu
ID: 1202152 • Letter: I
Question
Investment can be increased both by reducing taxes on private saving and by reducing the government budget deficit. It is difficult to implement both of these policies at the same time because reducing taxes on private spending has the effect of the government budget deficit. What would you need to know about private saving to judge which of these two policies would be a more effective way to raise investment? Check all that apply. The elasticity of private saving with respect to the after-tax real interest rate The response of private saving to changes in the government budget deficit The elasticity of investment with respect to the interest rateExplanation / Answer
Correct Answer:
Increasing the government budget deficit
Explanation:
Budget deficit is the difference between government spending and revenue collection. Tax collection is the major source of revenue collection. So, reducing taxes will reduce the overall revenue collection. It will broaden the difference between spending and revenue collection. Thus, government budget deficit will increase.
Correct Answer:
All three of the following will apply.
The elasticity of private savings with respect to the after tax real interest rate
Response in private savings to changes in government deficit
The elasticity of investment with respect to the interest rate
Explanation:
Elasticity of private savings in response to tax cut is important because it decides the degree of change in private saving with change in taxes. Private savings also respond to change in government deficit.
Decrease in government deficit can lead to decrease in private savings. Thus, it will not help in this scenario.
Response of investment with respect to the change in interest rate also needs to be measured. If investment is elastic then policy change will help and vice versa.
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