Chapter 12: Problem 8

When there is a recession, the biggest decline is in (LO3) a) Social Security tax receipts b) personal income tax receipts c) consumer spending d) corporate aftertax profits

Short Answer

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Based on the impact of a recession on each of the mentioned variables, the most significant decline occurs in corporate after-tax profits (option d). Businesses are directly affected by the drop in consumer spending and business investments, and reduced revenues and cost-cutting measures can dramatically impact after-tax profits. Therefore, the correct answer is option (d) corporate after-tax profits.

Step by step solution

Understanding what a recession is

A recession is an economic downturn characterized by a period of negative economic growth for two consecutive quarters. During a recession, the economy contracts, causing a decrease in economic activities such as employment, investment, and corporate profits. This decline affects various aspects of the economy, including government revenue, household income, and spending.

Evaluating the decline in Social Security tax receipts

During a recession, there may be a decline in Social Security tax receipts because the decrease in employment results in fewer people contributing to the program. However, the effects on Social Security tax receipts may be relatively small compared to other factors because these receipts are based on a percentage of payroll, and overall contribution rates typically remain steady.

Evaluating the decline in personal income tax receipts

Personal income tax receipts are closely related to overall income levels. During a recession, unemployment increases and wages may stagnate or decline, leading to a fall in household incomes. As a result, personal income tax receipts generally experience a significant decline during a recession, as individuals' taxable incomes decrease.

Evaluating the decline in consumer spending

Consumer spending is the primary driver of economic growth, accounting for about two-thirds of the GDP in most developed countries. Recessions usually come with heightened economic uncertainty, increased unemployment, and reduced household incomes. These factors contribute to lower consumer spending as households may cut back on non-essential purchases and become more cautious with their finances overall.

Evaluating the decline in corporate after-tax profits

Recessions have a direct impact on businesses and industries as well. As consumer spending falls and business investments slow, corporate revenues may decline. Additionally, a recession can lead to cost-cutting measures and reduced production due to lower demand. Consequently, corporate after-tax profits are likely to decrease significantly in a recession.

Identifying the most significant decline

Based on the impact of a recession on each of the mentioned variables, it seems that the most significant decline occurs in corporate after-tax profits (option d). The reason behind this is that businesses are directly affected by the drop in consumer spending and business investments. Furthermore, reduced revenues and cost-cutting measures can dramatically impact after-tax profits. Therefore, the correct answer to the question is option (d) corporate after-tax profits.

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