Question

According to the theory of supply-side economics, a cut in the tax rate will actually result in an increase rather than a decrease in tax revenues. Which statement best explains how this is supposed to happen?

Answer 1

Answer:

When the government lowers tax rates, both consumer spending and private investment increase, leading to an increase in economic growth which will in turn contribute to increase government revenue through a higher tax base.

Explanation:

For every dollar that an individual earns, two things happen:

1. propensity to consume: proportion of total income that individuals decide to spend instead of saving. Consumer spending increases private consumption.
2. propensity to save: proportion of total income that individuals decide to save instead of spending. All the money individuals save become private investment.