Suppose that Congress eliminates an investment tax credit and that the government reduces taxes on income earned from stocks and bonds at the same time. Assume the government runs a balanced budget throughout this process. Holding all else constant, what will be the effect on the equilibrium interest rate and investment?

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Business

Romeo

21 July, 22:08

Suppose that Congress eliminates an investment tax credit and that the government reduces taxes on income earned from stocks and bonds at the same time. Assume the government runs a balanced budget throughout this process. Holding all else constant, what will be the effect on the equilibrium interest rate and investment?

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Carlos Dougherty · Answer 1

The effect on the equilibrium interest rate and investmet should be almost null, and as result, the interest rate and the investment level should stay roughly the same.

Explanation:

This is because the two measures are contradictory, and more or less cancel each other out.

If the Congress eliminates an investment tax credit, this means that now investors will not be able to deduct certain investment costs before taxes, making investment more expensive, and reducing the incentive to engage in it.

But at the same time, the government reduces taxes on income earned from stocks and bonds, the two most common financial investment instruments, making investing more attractive.

Therefore, we have one measure from Congress that decentevizes investment, and another measure from the government that incentivizes investment, a combination likely causing the effect of the two to nullify.