Question

Suppose that the U.S. government increases income taxes on individuals earning more than $500,000/year and uses the revenue from this tax increase to subsidize the cost of energy for businesses. How will this policy change affect the U.S. economy

Answer 1

This policy will result in two opposing effects:

• the income tax will effectively reduce consumption, aggregate demand, and/or savings (resulting in lower investment).
• the energy subsidies will effectively increase production and aggregate supply, resulting in higher investment.

Depending on which effect is larger, the economy might grow or contract.