Question

An income tax hike

A. increases potential GDP.

B. increases employment.

C. decreases potential GDP.

D. Both answers A and B are correct.

E. Both answers B and C are correct.

Answer 1

The correct answer is option C.

Step-by-step explanation:

An increase in income tax will cause the disposable income of the consumers to decline. It will thus reduce consumer spending.

A reduction in the demand for goods and services will cause production to decrease. Firms will need fewer workers to produce output so employment will also decline.

This will further cause the aggregate demand and potential GDP to decline.