Economists use two multipliers to estimate the impact on GDP of an expansion in government spending associated with rising tax rates. The spending multiplier indicates the extent to which GDP rises as a result of the extra aggregate demand arising from the increased government spending. The tax multiplier indicates the impact of rising tax rates on GDP as labour supply is reduced because of the disincentives associated with taxation. The net effect on GDP is the sum of these two impacts.
Answer: False
The answer is False.
Mainstream economics analysis does posit that rising marginal tax rates distort the labour supply choice - by increasing the hourly cost of work and providing greater incenctives for workers to choose more leisure. This allegation forms the basis of their case for substantial tax cuts and proportional tax systems; and, as a consequence, reduced fiscal deficits.
As an aside there is no empirical evidence to support this claim. Most of the credible studies find very little evidence of a negative tax elasticity within normal ranges that these variables shift. The most significant tax effect is found at the intersection of the welfare system and the wage system where workers who work an extra hour while on benefits often face 100 per cent marginal taxes (loss of benefit equal to earnings). But that is another story again.
However, in terms of this question, the trick was in understanding what the tax multiplier is trying to conceptualise.
First, it is a macroeconomic rather than a microeconomic concept. Households are assumed to pay some tax out of gross income and the tax rate (keeping it simple) specifies that proportion. In reality, there are a myriad of tax rates but the total effect can be summarised by a single (weighted-average!) tax rate.
Households consume out of disposable income. Assume the overall propensity to consume is 0.80 - which means that overall consumers will spend 80 cents for every extra dollar of disposable income received.
So, if the tax rate rises, then disposable income falls. If nothing else changes, then this fall in disposable income will lead to a reduction in consumption (equal to the propensity to consume times the fall in disposable income). The resulting fall in GDP is defined as the tax multiplier.
Similarly, when tax rates falls and increase disposable income, the reverse occurs.
You should not confuse the hypothesised tax multiplier effect with the increase in tax revenue that occurs as a result of the automatic stabilisers. This effect occurs with no discretionary change in the tax regime. It is a common mistake to assume that because tax revenue is rising that tax policy is becoming contractionary.
Further, at the individual level, as GDP growth recovers most people will not be paying higher taxes at all while others will be paying a substantial increase - why? Because they move from unemployment (zero taxes paid) to earning an income (some taxes paid).
You may wish to read the following blog for more information: