Download Fiscal Policy, the Budget, and the National Debt

Chapter 17: Fiscal Policy
and the Federal Budget
Fiscal Policy -- the Federal government
changing its government budget
position (G - T) in order to stabilize the
economy.
Fiscal Policy, by its nature, alters the
Federal Budget. This chapter also
examines the Federal Budget, what it’s
made up of, and when budget deficits
can be a problem in the economy.
The Federal Budget
Federal Budget (or Budget) = Tax
Revenues - Government Expenditure
(over a given period).
Federal Budget (or Budget) = Tax
Revenues - (Government Purchases of
Goods and Services + Transfer
Payments + Interest on the National
Debt).
Budget Definitions
Budget < 0 -- Budget Deficit
Budget > 0 -- Budget Surplus
Budget = 0 -- Balanced Budget
Realistic Goal -- Balanced Budget
when Y = YF.
The US Federal Budget:
2003 (Billions of Dollars)
Tax Revenues
Government
Expenditure
Federal Budget
$1974.8
$2381.3
-$406.5
Source: Economic Indicators,
October 2005.
Breakdown of
Tax Revenues
Personal Income Taxes = $801.8
Corporate Profits Taxes = $217.4
Taxes on Production
and Imports (e.g. sales
and excise taxes)
= $94.0
Contributions for
Social Insurance = $803.5
Other
= $58.1
Breakdown of
Government Expenditure
Purchases of
Goods and Services (G)
Transfer Payments
Interest Payments
Other
= $725.7
= $1391.2
= $221.5
= $42.9
Source: Economic Indicators,
October 2005.
The Budget: In Our Notation
Recall variable definitions:
-- T = net taxes
= tax revenues
- (transfer payments
+ interest on the
national debt)
-- G = government purchases of
goods and services
The Budget and
The Budget Position
Budget = T - G
Budget Position (or size of deficit)
=G-T
The National Debt
The National Debt -- The total
accumulated stock of debt owed
by the government to its lenders
(holders of government bonds).
Expanded by budget deficits,
reduced by budget surpluses.
National Debt -Realistic Goal
Realistic Goal -- consider the
Debt-Income Ratio =
(National Debt)/(GDP).
For the US in 2004 =
($4295.5)/($11734.3) = 0.366.
Source: Economic Indicators,
October 2005.
The Income Tax and
Automatic Stabilization
Automatic Stabilization -- due to
the income tax system, tax
revenues change in directions that
help to stabilize the economy,
without any change in the tax
structure (i.e. fiscal policy).
The Income Tax as an
Automatic Stabilizer
Y* (maybe > YF)  Tax Revenues
helps to cool the economy
Y* (maybe < YF)  Tax Revenues
helps to stimulate the economy
Note -- all this takes place without
any change in the tax structure, as
prescribed by fiscal policy.
The Income Tax
and the Federal Budget
Y*  Tax Revenues  T
 (T - G)
A strong and growing economy
improves the budget.
Y*  Tax Revenues  T
 (T - G)
A weak economy generates a
lower budget.
Strategy of Fiscal Policy
Expansionary policies seek to
induce more purchasing of goods
and services by increasing (G - T)
-- i.e. G or T.
Contractionary policies seek to
induce less purchasing of goods
and services by decreasing (G - T)
-- i.e. G or T.
Specific Types
of Fiscal Policy
Change Government Purchases of
Goods and Services (G)
-- Expansionary: G
-- Contractionary: G
Change Transfer Payments (TP)
-- Expansionary: TP
-- Contractionary: TP
Tax Policy as Fiscal Policy
Change Marginal Tax Rates (t)
-- Expansionary: t
-- Contractionary: t
Change Tax Deductions
-- Expansionary: Bigger Deductions
-- Contractionary: Smaller Deductions
Change Indirect Business Taxes
(e.g. Sales or Excise Taxes)
-- Expansionary: Lower Taxes
-- Contractionary: Raise Taxes
Fiscal Policy
in the AD-AS Model
Expansionary Fiscal Policy shifts
the AD curve rightward, increases
Y* and P*.
Contractionary Fiscal Policy shifts
the AD curve leftward, decreases
Y* and P*.
Note -- like monetary policy, fiscal
policy is justified only from a
short-run perspective.
Obstacles to
Fiscal Policy Effectiveness
Difficulties in getting the proper
policy passed through Congress
and the president.
A tax cut that isn’t used for
spending. AD curve does not shift
rightward, no change in Y*.
Worries about the Federal Budget
within a sluggish economy.
The Crowding Out Effect -An Adverse “Side Effect”
The Crowding Out Effect -Expansionary fiscal policy creates
an increased need for more
borrowing by the government.
This financing increases the
demand for financial capital. As a
result, long-term interest rates (r*)
rise and Investment (I*) decreases.
The Crowding Out Effect -Fiscal Policy Effectiveness
Crowding Out Effect -- makes
fiscal policy less effective than
would be otherwise.
Decrease in investment to some
extent offsets rise in (G - T).
Smaller shift in AD curve than
would be without the crowding out
effect.
The Crowding Out Effect –
Impeding Economic Growth
Crowding Out Effect  loss of
Investment (I).
Decrease in Investment retards the
buildup of the capital stock and
possible implementation of new
technology (i.e. Labor Productivity
growth).
Smaller shifts in LAS curve, smaller
increases in YF.
Ways to Avoid the
Crowding Out Effect
Bottom line -- get the supply of
financial capital to shift rightward
at the same time as when
expansionary fiscal policy occurs.
-- expansionary monetary policy
-- increased private saving
-- increase in foreign capital
inflows
Distinctive Fiscal Policy
Actions in the US
World War II
The Kennedy-Johnson Tax Cut of 1964
The Nixon Tax Increase of 1969
The Reagan Economic Recovery and
Tax Act of 1981
Clinton Tax Increases of 1993
Bush Tax Cuts of 2001-03
Bush Tax Rebates of 2008
Obama Fiscal Stimulus Plan of 2009