Final answer:
A one-time tax increase has no effect on permanent income but reduces current disposable income. Permanent changes in fiscal policy, in contrast, affect long-term financial planning and therefore can change permanent income. People respond differently to these changes; they are more likely to alter spending habits in response to permanent fiscal policy changes.
Step-by-step explanation:
When there is a one-time increase in taxes with no change in the time path of government purchases, the change in permanent income is essentially zero. This is because a permanent income, according to economic theory, reflects an individual's normal or average lifetime income. A one-time tax increase does not alter the anticipated income over a person's lifetime. However, it does reduce current disposable income, which is the income that individuals have available to spend or save after taxes.
In contrast, a permanent change in fiscal policy, such as a long-term tax increase or cut, would lead to a change in permanent income since it affects the long-term outlook of an individual's financial situation. This is because people and firms adjust their consumption and saving behavior based on their expectations of future income, and a permanent change in taxes would alter those expectations.
The economic effects of temporary versus permanent fiscal policy changes are quite distinct. People are more likely to alter their spending habits significantly in response to a permanent change than a temporary one, as temporary measures are seen as less likely to affect long-term financial planning.