Option B, an $85 billion cut in federal government spending, would have a larger negative impact on aggregate demand and real GDP according to the document. A tax increase of $85 billion distributed among high-income households would reduce consumer purchasing power but the impact would be lessened by the marginal propensity to consume being less than one. In contrast, a direct cut to government spending of the same amount would have no multiplier impact.

1. 6) Which of the following fiscal policy changes would have a larger overall negative impact on
AD and RGDP? Explain your answer in a paragraph or two with credible logics and analysis.
A) A program of tax hike, distributed uniformly across the households earning over $300K
annually filing tax returns, amounting to $85 billion in total tax hikes.
Alternatively,
B) An $85 billion sequester (called automatic federal government spending cut) that went into
effect on March 1, 2013. This was an across-the-board spending cut in federal government
Solution
A) A program of tax hike, distributed uniformly across the households earning over $300K
annually filing tax returns, amounting to $85 billion in total tax hikes.
Ans: Increase in the tax rate would reduce the purchasing power of consumer. Now they
would be compelled to spend less. It would have multiplier impact.
Total Change = b/1-b *85 Billion
b is Marginal Propsensity to cosumer (MPC)
Alternatively,
B) An $85 billion sequester (called automatic federal government spending cut) that went into
effect on March 1, 2013. This was an across-the-board spending cut in federal government