Download Fiscal policy

•Keynesian view
•Discretionary versus non-discretionary fiscal policy
•The automatic stabilizers
•Fiscal policy to close a contractionary gap.
•Fiscal policy to close an expansionary gap.
•Problems with fiscal policy
•Principles of taxation
•The Federal Deficit and the National Debt
The use of the taxing and spending powers of
government to regulate aggregate expenditure,
and thereby to stabilize the economy
The economy needs to be
stabilized. The economy
can be stabilized. The
economy should be
stabilized. This is the
Keynesian view
This legislation
established a
responsibility for the
federal government to
promote “maximum
employment,
production, and
purchasing power.”
Discretionary fiscal policy is the deliberate
manipulation of government purchases, taxation, and
transfer payments to pursue macroeconomic goals
such as full employment and price stability.
The Bush tax stimulus package of
2008 and the Obama stimulus
package of 2009 are examples of
discretionary fiscal policy
Federal Spending as a Percent of GDP, 1990-2007
2.8
2.6
7
2.4
6
2.2
5
2.0
4
3
90
92
94
96
Defense Spending
98
00
02
04
06
Non-Defense Spending
Source: Bureau of Economic Analysis
Non-discretionary or “built-in” features of
government spending and taxation that reduce
fluctuations in disposable income, and thus
consumption, over the business cycle.
•Tax rates for various types of income are set by elected
officials. Tax collections depend on the employment
levels/incomes, profits, capital gains, retails sales, . . .
•Elected officials establish eligibility requirements and support
levels for needs-tested transfer payments—e.g., TANF, food
stamps, and unemployment compensation. Actual government
outlays for needs-tested transfer payments depend on (1) the
number of persons eligible; and (2) the number of those
eligible that actually file claims.
As the economy enters a recession,
federal revenues tend to decline
while at the same time transfer
payments rise. Thus recession
brings about an automatic decline
of net taxes (NT)
Remember that: DI = Y - NT
 Y  NT  DI
 Y  NT  DI
G, T
Potential
GDP
T = TX - TR
G
Deficit
0
Balanced budget at
full-employment
Y1
Real GDP
If a lack of aggregate expenditure is
the problem, why not use the
spending and taxing powers of the
federal government to stimulate
aggregate expenditure
How Fiscal Policy Works
Y  GDP  G 
1
1  MPC  MPM  MTR
AE
AE2
AE1
G
Full
employment
GDP
0
Y1
YFE
Real GDP
The preceding slide
illustrates the type of
expansionary fiscal policy
that Keynesians
recommend for recession.
We will now use the AS-AD
framework to illustrate
contractionary fiscal policy.
Modeling Contractionary Fiscal Policy
Price Level
Potential
GDP
AS
AD2
AD1
0
Y1
Real GDP
YF is full-employment (potential) GDP.
AE
AE’
AE
•Increase in G
•Decrease in NT
a  bNT  I  G  ( X  M )
Y
YF
Contractionary gap
Real GDP (Y)
1. Policy lags
2. Permanent income
Principles of Taxation
•Horizontal equity: Tax code should be written so that
those in the same economic circumstances pay the same
amount in taxes.
•Vertical equity: Tax code should be written so that
those in different economic circumstances should pay an
unequal amount in taxes.
•Benefits received principle: Those who derive more
benefits from government programs should pay more
taxes.
•Taxable income: Gross income - income exempt
from taxes. Example: For single filers who use the
1040EZ:
Gross Income:
$35,000
Minus:
Standard deduction
7,050
Equals:
Taxable income
$27,950
•Average tax rate (ATR): Tax payments as a
percent of taxable income.
•Marginal tax rate (MTR): The tax rate applied to
the last dollar of taxable income.
•Progressive tax: The proportion of taxable
income taken in taxes increases as taxable
income increases.
•Regressive tax: The proportion of taxable
income taken in taxes decreases as taxable
income increases.
•Proportional tax: The proportion of
taxable income taken in taxes remains
constant as taxable income increases.
Needy
By making the tax
structure “progressive,”
governments can make
the after-tax distribution
of income more equitable
(or even).
Affluent
Federal personal Income Tax rates Under the
1993 Tax Reform Act
(Married couple filing jointly)
Total Taxable
Income
Marginal Tax
Rate (%)
$0
0%
0-36,900
36,901-89,150
15
28
89,151-140,000
31
140,001-250,000
36
250,000 and up
39.6
Average and Marginal Tax Rates under the Tax
Reform Act of 1993 (for a couple with 2 children)
Income
$10,000
20,000
30,000
50,000
75,000
150,000
250,000
400,000
Tax
$0
272
1,766
4,766
10,315
32,140
66,802
128,710
Ave. Tax Rate Marginal Tax Rate
0%
0%
1.4
15
5.9
15
9.5
15
13.8
28
21.4
31
26.7
36
32.2
39.6
Tax Brackets for 2003 under the 2001 Tax
Reform Act
2003 Taxable Income
Marginal Tax Rate
$0-$12,000
10.0%
$12,000-$47,500
15.0
$47,500-$114,650
27.0
$114,650-$174,700
30.0
$174,700-$311,950
35.0
Over $311,950
38.6
Source : Wall Street Journal
Quick Facts about President Bush’s Tax Bill
•The 39.6% tax rate reduced to 33%
•The 36% tax rate reduced to 33%
•The 31% rate reduced to 25%
•The 28% rate reduced to 25%
•The current 15% bracket is retained over most of its range
•A new 10% bracket applies to the lowest ¼ of 15% range.
•Maximum rate on capital gains reduced from 28 to 15
percent.
President Bush comments (wav)
Fun Fact: Of the $477 billion in federal tax cuts over 10 years, 52 percent go to
the top 1 percent of households (average income: $343,000). Source: Center
for Tax Justice
The Bush tax cuts are scheduled
to expire in 2010. Senator
McCain favors renewing them—
even though he voted against
the Bush tax bill in 2001.
Senators Clinton and Obama
support raising marginal rates on
capital gains and also for high
income families.
Assume a 7.13 percent excise tax on groceries,
gasoline, cigarettes, and liquor
(1)
Family
Income
(2)
Spending for
items subject
to excise tax
(3)
=
(2)/(1)
(4)
(5)=
(4)/(1)
Greens
$27,000
$16,200
.60
$1,188
4.4%
Jones
64,000
25,600
.40
1,871
2.9
Lemons
270,000
40,500
.15
2,961
1.0
Excise Tax
Paid
ATR
Moral of the story: Low income families tend
to spend a greater proportion of their income on
items subject to excise taxes. Hence excise taxes
tend to be regressive.
The Arkansas state sales
tax on groceries was
reduced from 6 percent
to 3 percent effective July
1, 2007
In the case of a federal deficit, the
Treasury must borrow. The national debt
is the accumulated borrowing of the
federal government in all previous
fiscal years, minus what has been repaid
For updated information, check the National Debt Clock
Is a large national debt a bad thing?
Arguments against a large national debt include:
•The “burden on future generations” argument.
•A large national debt means that a significant
share of federal spending must be allocated for
interest payments—leaving less for other priorities.
•A large national debt makes the U.S. too
dependent on foreign financial inflows.
•Federal borrowing “crowds out” private sector
borrowing units—i.e., firms and households.
“[W]e (the U.S.) owe
$5.7 trillion in debt and if we
don’t pay it off, our children
and our grandchildren are
going to have to.”
Congressman Marion Berry, in a
speech to the Jonesboro Lions
Club on April 16, 2001.
Interest payments as a Percent of Federal Expenditures (Annual)
18
16
14
P
e
r
c
e
n
t
12
10
8
6
4
2
0
1965
1970
1975
www.economagic.com
1980
1985
Year
1990
1995
2000
As long as the debt grows by the same
percentage as nominal GDP, the ratios of debt to
GDP will remain constant. In this case, the
government can continue to pay interest on its
rising debt without increasing the average tax
rate in the economy.
Click image below to enlarge.
National Debt Graph (2007 Budget data)
Who Owns the National Debt?
Agencies and Trusts
1814 / 26%
Privately Owned
3342 / 48%
Foreign Inves tors
1271 / 18%
Fed. Reserve Banks
463 / 7%
Source: Federal Reserve