1. Consider the following two positions on tax policy:     "A tax cut to the poor rather than to the rich is not only more just, but also dollar for dollar serves to stimulate the economy more".     "A tax cut to the rich rather than the poor is just because they pay much more in taxes. But it also leads to faster economic growth, which will eventually make the poor better off as well." Explain the rationale behind these two statements in the light of the economic models we have developed.

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The income tax multiplier, dY/dt, depends on the marginal propensity to consume. The higher the marginal propensity to consume, the greater the increase in output caused by a tax cut of a given size. It should be intuitive that poor people tend to spend a greater fraction of their income, and that they would spend a greater fraction of any additions to their income. Thus, the marginal propensity to consume is higher for poor people, and the tax multipler would be larger if the tax cut is directed at them rather than at the rich.

The second quote is a mirror argument. If the marginal propensity to consume is larger for the poor, it follows that the marginal propensity to save is larger for the rich. Thus, a tax cut will induce a greater increase in saving if it is directed at the rich. The increase in saving lowers the real interest rate and stimulated investment. This in turn raises the capital stock so that future output is higher.

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