Tax Multiplier vs. Spending Multiplier

by Andra Picincu - Updated June 29, 2018
Cropped Hand Of Man Using Calculator On Desk At Office

Customers are the lifeblood of your business. Their spending power depends mainly on the government's policies. Even the slightest change in taxes or wages can affect their ability to buy your products. For this reason, it's vital that you understand the role of fiscal multipliers and how they impact the business cycle.

Fiscal policy effects can either increase or reduce customer spending power. For example, a decrease in income tax will allow customers to purchase more goods, which translates into higher revenue for your business.

Raising taxes will have the opposite effect. Customers will earn and spend less money. Fiscal multipliers help measure the degree to which these actions affect spending power and influence investment decisions.

What Is a Tax Multiplier?

This number indicates the multiple by which GDP (gross domestic product) increases in response to tax reductions. Business owners can use tax multiplier calculations to determine how much customers will spend if the government lowers taxes. Under these conditions, customers will have a higher disposable income, which allows them to add to their savings, gives them more spending power and enables them to buy more expensive goods.

Tax reductions also cause an increase in disposable income. As customer demand increases, so does the production of goods, which leads to economic growth and higher profits for businesses. When the government raises taxes, both customers and businesses lose money. At the same time, investment rates drop, which further affects the economy.

Understanding the Government Spending Multiplier

The spending multiplier measures fiscal policy effects on the economy. It shows how GDP increases or decreases in response to the changes in government spending. This number is related mainly to how much consumers save. Any change in the government’s activities will have a significant impact on a country's economy and consumer purchase power.

If a country's government spending increases, the money spent goes back into the economy. As a result, customers continue to spend and save. And when government spending decreases, consumers' disposable income drops. This is why governments encourage spending during recessions as a means to stimulate economic growth.

Understanding fiscal policy effects are crucial to your company's growth and revenue. As a business owner, you can anticipate customer spending trends and patterns based on multiplier calculations. An increase in taxes will decrease disposable income, while a tax reduction will have the opposite effect.

Furthermore, GDP growth is dependent on the fiscal policy. Multiplier calculations can play a key role in ensuring macroeconomic forecast accuracy. Once you know these numbers, you can adjust your business strategies accordingly.

About the Author

Andra Picincu is a digital marketing consultant with over nine years of experience. She works closely with small businesses and large organizations alike to help them grow and increase brand awareness.

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