[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Everyone has to pay taxes!
The Effects of Changes in Taxes While we have focused on changes in
expenditures, the same analysis enables us to understand how the economy would
be affected by a tax cut not balanced by a cut in government expenditures. A tax
cut increases households’ disposable income. To make the example concrete, suppose
taxes are reduced by $100 billion. As a result, disposable income rises by the
full $100 billion that households no longer need to pay to the government as taxes.
They will use this additional disposable income to increase their current consumption
spending and to increase their saving. 2 For example, aggregate consumption
might rise by $90 billion and saving by $10 billion. If this is the case, private saving
will rise by $10 billion, but national saving will fall because the government’s deficit
rises by $100 billion. Therefore, national saving falls by $90 billion. The leftward
shift in the savings curve leads to a higher equilibrium real interest rate and a lower
level of investment.
Balanced Budget Changes in Expenditures and Taxes The previous
examples considered cases in which expenditures or taxes were changed, leading
to changes in public saving. But what happens if the government changes both
expenditures and taxes by the same amount so that public saving remains
unchanged? Suppose initially that the government has a balanced budget: that is,
2 This does not mean every household will use some of the tax cut to increase their saving. Many households might
decide to spend the entire amount. Others might decide to save it all. But when we add up all the households
in the economy, both aggregate consumption and aggregate saving will have increased.
552 ∂ CHAPTER 25 GOVERNMENT FINANCE AT FULL EMPLOYMENT