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A government is running a balanced budget. An election is approaching and the gov- ernment decides on a one-time, temporary massive tax cut that will cut tax revenue by $50 billion in one year; after the year is over, tax rates and tax revenue return to normal. The government decides to issue perpetual bonds of $50 billion to cover the cost of the tax cut. The interest rate on these bonds is constant at 6%. The tax to pay the interest in the future will be levied on the private sector. Suppose that one-half of the population plans ahead and wants to leave enough in bequests to the next generation so they are not harmed by future higher taxes. The other half of the population spends all they can now.

(a) What is the impact of the tax cut on domestic saving?

(b) What happens to consumption?

(c) Who buys the $50 billion of debt?

Microeconomics, Economics

  • Category:- Microeconomics
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