AP MacroeconomicsFiscal Policy
Balanced Budget Multiplier
The balanced budget multiplier equals 1: an equal rise in government spending and taxes raises real GDP by exactly the amount of the spending change.
Government spending enters the economy directly (multiplier = 1/(1-MPC)), but a tax increase only reduces spending indirectly because households cut consumption by just MPC times the tax (multiplier = -MPC/(1-MPC)). Adding the two effects, the larger spending multiplier exactly outweighs the smaller tax multiplier, leaving a net multiplier of 1. So a $100 spending increase fully funded by a $100 tax increase raises GDP by $100. This shows balanced-budget fiscal expansion is still expansionary, contrary to a common intuition that it would be neutral.
Formula / Example
Spending multiplier + Tax multiplier = 1/(1-MPC) + (-MPC/(1-MPC)) = 1