Progressive tax regimes imply that the effective tax rate on the private sector is pro-cyclical?

CFA Level III Economics
#1

Reading 10, EOC Q7 solution: Country Y is expected to significantly increase transfer payments and introduce a more progressive tax regime. Both of these changes are pro-growth government policies and should have a positive impact on the trend rate of growth for a business cycle that is in slowdown or contraction. Transfer payments help mitigate fluctuations in disposable income for the most vulnerable households, while progressive tax regimes imply that the effective tax rate on the private sector is pro-cyclical (i.e., rising as the economy expands and falling as the economy contracts).

(Institute 216)

Institute, CFA. 2020 CFA Program Curriculum Level III Volume 2 . CFA Institute, 08/2019. VitalBook file.

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#2

Do you have a question?

#3

Yes sorry, i meant to ask why does progressive tax regimes imply that the effective tax rate on the private sector is pro-cyclical?

#4

Progressive tax regime --> The higher the income, the higher the marginal tax rate.

That means the when economy is growing/expanding, income increases hence higher taxes --> higher effective tax rate (i.e. effective tax rate is positively related to a growing economy if progressive tax rate system is used).

#5

Thank you!

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