Lump-sum tax
Topic: Government Budget, Fiscal Policy and FRBM · NCERT: Class 12, Ch 5 "Government Budget and the Economy"
Meaning
A lump-sum tax is a fixed tax amount (T) that does not change when income changes. A person pays the same tax whether they earn more or less. The tax lowers disposable income (the income people have left to spend) by T, so consumption falls by cT, where c is the marginal propensity to consume (the share of each extra rupee that people spend). The consumption line and the aggregate demand (AD) line (total spending in the economy) therefore shift down in parallel. Their slope stays the same.
Tax multiplier with a lump-sum tax = −c/(1 − c)
Example
In NCERT's example with c = 0.8, the tax multiplier is −0.8/0.2 = −4. So a lump-sum tax cut of 100 raises income by 4 × 100 = 400. The same rise in government spending would raise income by 500.
Don't confuse with
- Proportional tax (T = tY): this tax rises with income. It does not shift AD in parallel. It makes AD flatter and gives a smaller multiplier, 1/[1 − c(1 − t)].
Related concepts
- Fiscal policy
- Government expenditure multiplier
- Tax multiplier
- Transfer multiplier
- Balanced budget multiplier
- Fiscal multiplier