How do tax multipliers differ from spending multipliers in practice?

• A. Government spending multipliers tend to be larger because spending directly adds to aggregate demand, while tax multipliers are typically smaller and negative as some tax cuts are saved.
• B. Tax multipliers are larger because tax cuts immediately increase consumption more than spending.
• C. They are identical in all cases.
• D. Tax multipliers are larger since they boost investment more than spending.

Answer: (A)

The key idea is how policy changes pass through to aggregate demand. When the government spends money, it directly increases demand today. The recipients then use a portion of that additional income to buy more goods and services, which creates another round of spending, and so on. This direct injection tends to produce a relatively large multiplier because it adds to spending with minimal delay and leakage.

A tax change works through households’ after-tax income and their spending behavior. A tax cut increases take-home pay, but how much of that extra income is spent depends on how much people choose to consume versus save. If part is saved, the boost to demand is smaller, so the multiplier is smaller in magnitude. If taxes rise, the effect on demand is negative, but the magnitude is typically smaller than the spending multiplier for an equal-sized change because not all of the tax change translates into immediate spending.

So, in practice, spending multipliers are larger than tax multipliers. The other options misstate the mechanism: tax cuts do not automatically generate more consumption than spending, multipliers are not identical, and tax policy does not inherently boost investment more than spending in a straightforward way.