Download Document

Fiscal Policy
Claudia Garcia-Szekely
5/23/2017
© 2002 Claudia Garcia-Szekely
1
War is the mother of taxes
Saint Gregory Nazianzus
And also the mother of
inflation…
5/23/2017
© 2002 Claudia Garcia-Szekely
2
"We're going to be putting money in people's pockets so that
they can spend on buying a new computer for their kid's
school, so that they can, you know, make sure that they
are able to deal with heat and groceries and all the other
strains on the family budget,“
President elect, Obama.
3
Fiscal Policy
Changes in Government Spending and/
or Taxes.
Induce a change in Aggregate
Spending.
Increase AE
Decrease AE
5/23/2017
© 2002 Claudia Garcia-Szekely
4
Expansionary Policy
Increase AE
Increase Output and Employment
Increase Government Spending (DG)
And or
Decrease Taxes (DT)
5/23/2017
© 2002 Claudia Garcia-Szekely
5
G
Circular Flow Diagram
National
Income
generated
from
production
to
T
S
National Income
- Taxes + Transfers
Households
C
I
G
G
Rest of
World
pay
Firms
NX
Total
Produced
Disposable Income is Income
available for consumption.
Income generated from production is
used to:
Buy goods and services: C.
Save: S
Pay taxes: Tx
The government pays “income
transfers” to households.
Social Security
Welfare
Unemployment benefits
5/23/2017
© 2002 Claudia Garcia-Szekely
7
Adding Net Taxes
The government collects taxes
Use Tx for Taxes
The government pays Transfers
Use Tr for Transfers
We are only interested in the NET
effect on Incomes.
Use T for Net Taxes = Tx - Tr
5/23/2017
© 2002 Claudia Garcia-Szekely
8
Net Taxes
T = Tx - Tr
Net amount paid in taxes to the
government after subtracting
transfers
5/23/2017
© 2002 Claudia Garcia-Szekely
9
FixedTaxes (Lump
Sum)
Fixed taxes do not change with
income.
5/23/2017
© 2002 Claudia Garcia-Szekely
10
Disposable Income
Yd = Y - T
Income left after:
Paying taxes
Receiving Government Transfers
Income available for Consumption
and Saving
5/23/2017
© 2002 Claudia Garcia-Szekely
11
The effect of the tax cut
C = a + b Yd
C = a + b (Y-T)
C = a + bY- bT
C = (a – bT) + bY
Fixed taxes
change the
intercept of the
consumption
function
A tax cut increases or increase in
transfers the intercept of the
consumption function.
Changes in T shift the
Consumption Function.
5/23/2017
© 2002 Claudia Garcia-Szekely
12
Government Spending and
Taxes affect AE differently
Government
Spending (G) Enters directly into AE
AE = C+I+G
Taxes, transfers Enter indirectly
(T)
into AE via C
AE = +I+G+ C
5/23/2017
© 2002 Claudia Garcia-Szekely
13
The effect of a 70 tax cut
Disposable Income
When Taxes
Consumers have
increase by
Decrease by DT = -70 70 more to spend
D Yd = 70
When D Yd = 70
When D C = 63
When D AE = 63
5/23/2017
C = a + MPC(Yd)
AE = C + I + G
AE = C + I + G
© 2002 Claudia Garcia-Szekely
C increase by
D C = 0.9 (70)
AE increase by
D AE = D C = 63
AE line shifts up
by 63.
14
The effect of A Decrease in
Taxes: DT = -70 MPC = 0.9
Taxes change by
(DT)=-70
Yd =Y-T change
by –(DT)=70
Consumption
changes by
–(DT)MPC=70(0.9)
AE shifts up by
–(DT)MPC
DAE = DC=-DT(MPC)
=-(-70)(0.9) =63
5/23/2017
DY = DC(1/1-MPC)
DY = 63(1/1-0.9)
DY = 63(10)=630
450
AE= C+I+G
AE= C+I+G
DC =630*0.9=567
63
630
DY = 63(10)
© 2002 Claudia Garcia-Szekely
15
The effect of A Change in
Government Spending
45
If government Spending
increases by DG = 70
AE line Shifts up
by DAE= DG = 70
Equilibrium Income
increases by:
DY = 70(1/1-MPC)
AE1
AE0
DC =700*0.9=630
DAE = DG = 70
DG =70
DY = 700
DY = DG(Multiplier)
5/23/2017
© 2002 Claudia Garcia-Szekely
16
The Tax Multiplier
An extrais
$70smaller
in your
hands doesn’t go as far
than the G Multiplier
as the same $70 spent
Taxes decrease by 70
by the government!
45
Why?
G increases by 70
AE1
AE1
AE0
AE0
70
63
630
700
DY = 63(10)
DY = 70(10)
5/23/2017
45
© 2002 Claudia Garcia-Szekely
17
Government Spending vs. Tax
Cuts
The $787 B stimulus package includes
$70 billion in tax cuts, which some
economists believe will not create as
many new jobs as $70 billion in
spending would…
5/23/2017
© 2002 Claudia Garcia-Szekely
18
When taxes
decrease by 70
MPC=0.9
45
AE1
AE0
630
P0
70*0.9
AD1
70*0.9 * 10
Y0 * Multiplier
Y1
70*MPC
AD0
Y0
Y1
The size of the change in equilibrium Y is the size of the shift in AD
When G increases
by 70
MPC=0.9
45
AE1
AE0
700
P0
70
AD1
70*10
Y0 Multiplier
Y1
70*
AD0
Y0
Y1
The size of the change in equilibrium Y is the size of the shift in AD
The G Multiplier
45
Dc
DG
YIncomes
0
Increase
Y1
= DGDG
(1/(1-b))
DYDY =
+ DC
Output
The G Multiplier
45
700*0.9
70
700
DY = DG + DC
Y
700 = 70 + 630
Output
The G Multiplier
45
Dc
Dc
YIncomes
0
Increase
Y1
DYDY ==DGDc(1/(1-b))
+ DC
Output
The T Multiplier
45
630*0.9
63
630
DY = DC + DC
Y
630 = 63 + 567
Output
Change in Consumption
When government spending changes:
The resulting change in spending is the sum of the
extra government spending + extra consumption
induced by the increase in incomes
DY = DG + DC
DC = DY – DG
DC = 700 – 70 =630
When taxes change all the resulting change in
spending is the extra consumption induced by the
increase in incomes:
DC = DY = 630
Changes in Budget Deficit
When government spending changes, the resulting change
in the Budget Deficit is:
D Deficit = DG= 70
When taxes change, the resulting change in the Budget
Deficit is:
DDeficit = -DT=-(-70)
The Tax Multiplier
D Y = DC x
DC=-DT(MPC)
D Y = -DT(MPC) x
D Y = DT
5/23/2017
[
[
[
1
(1- MPC)
1
(1- MPC)
- (MPC)
(1- MPC)
© 2002 Claudia Garcia-Szekely
]
]
]
27
The Tax Multiplier
5/23/2017
D Y = DT
[
D Y = DT
[-
- (MPC)
(1- MPC)
]
(MPC)
(MPS)
© 2002 Claudia Garcia-Szekely
]
28
The Tax Multiplier Formula
D Y = DT
[
- (MPC)
(1- MPC)
A negative
Number!
5/23/2017
© 2002 Claudia Garcia-Szekely
]
Taxes and
Output move in
opposite
directions
29
The Tax Multiplier
Smaller
D Y = DG
D Y = DT
Negative
5/23/2017
[+
(MPS)
]
[-
(MPC)
(MPS)
]
1
© 2002 Claudia Garcia-Szekely
30
The Balanced Budget
Multiplier
Captures the effect on
equilibrium output from
simultaneous identical changes
in Taxes and Government
Spending
5/23/2017
© 2002 Claudia Garcia-Szekely
31
Increase Both G and T by 40
DY = DG
1
1-MPC
DY = 40
1
What happens if
-MPC
the
DYwe=finance
DT
extra spending
with higher 1-MPC
taxes?
DY = 40
1-0.75
-0.75
1-0.75
DY = 40 (4)=160
DY = 40 (-3)=-120
DY = 160 – 120= 40
5/23/2017
© 2002 Claudia Garcia-Szekely
32
The Balanced Budget
Multiplier is ONE
If DG = DT = 40
DY = 40 (1)
5/23/2017
© 2002 Claudia Garcia-Szekely
33
Changes in Consumption
When government spending changes:
The resulting change in spending is the sum of the extra
government spending + extra consumption induced by the
increase in incomes:
DC = DY - DG
When taxes change all the resulting change in spending is
the extra consumption induced by the increase in incomes:
DC = DY
Balanced Budget change: multiplier effect is completely
eliminated.
There is NO extra consumption because the increase in
incomes and consumption triggered by the increase in G is
eliminated by the drop in incomes and consumption
resulting from higher taxes:
DY= DG ; DC = 0
Changes in Budget Deficit
When government spending changes, the resulting change
in the Budget Deficit is:
DDeficit = DG
When taxes change, the resulting change in the Budget
Deficit is:
DDeficit = -DT
When both Government Spending and Taxes change by
the same amount (a balanced budget change), there is no
change in the Budget Deficit :
D Deficit = 0
Income Tax: changes with income
VARIABLE TAXES
5/23/2017
© 2002 Claudia Garcia-Szekely
36
Variable Taxes: tY
Fixed Taxes
C = a + b(Y-T)
C and AE
C = a + bY – bT
C = (a –bT) + bY Slope =b
Example:
C = 1000 + 0.9(Y-700)
C = 1000 + 0.9*Y – 0.9*700
C = (1000 –0.9*700) +
0.9*Y
C = (1000 – 630) + 0.9Y
Variable Taxes
T= tY
C and AE
C = a + b(Y- tY)
Slope =b-bt
C = a + bY-b tY
C = a + (b-bt) Y
Example:
C = 1000 + 0.9(Y-0.25Y)
C = 1000 + 0.9Y – 0.9*0.25Y
C = 1000+ Y(0.9-0.9*0.25)
C = 1000 + (0.9-0.225)Y
O.675
slope smaller
37
Variable Taxes: tY
Variable Taxes
Fixed Taxes
T=T+ tY
C = a + b(Y-T)
C = a + b(Y- (T+tY))
C and AE C = a + bY-b(T+tY)
C and AE
C = a + bY – bT
Slope =b-bt
C = (a –bT) + bY Slope =b C = a + bY-bT-btY
Example:
C = (a –bT)+ (b-bt)Y
C = 1000 + 0.9(Y-700)
Example:
C = 1000 + 0.9*Y – 0.9*700 C = 1000 + 0.9(Y-700 -0.25Y)
C = (1000 –0.9*700) +
C = (1000 – 630) + (0.90.9*Y
0.9*0.25)Y
C = (1000 – 630) + 0.9Y
C = (1000–630) + Y(0.9-0.225)
C = 1000–630 + O.675Y
Intercept same, slope38smaller
Variable taxes make C and
AE flatter
I+G+NX+a
a-bT
I+G+NX+a–bT
a –bT
flatter
Steeper
When T Increases:
C shifts down
5/23/2017
When t Increases:
C becomes flatter
© 2002 Claudia Garcia-Szekely
39
Variable taxes make C and
AE flatter
C
Steeper: increase in
C is larger
DC=100*MPC = 100*0.9 = 90
C
Flatter: increase in
C is smaller
DC=100*(MPC-MPC*t) = 100*(0.9-0.9*0.25)= 67.5
DY=100
Part of the increase in income goes to pay taxes
so consumption does not increase as much.
Variable Taxes(tY) affect the
When t rate
multipliers
increases,
Fixed Taxes
multiplier
decreases
D Y = DG
[
1
(1- b)
D Y = DT
[
-b
(1- b)
]
]
Variable Taxes
D Y = DG
[
D Y = DT
[
1
(1-b+bt)
-b
(1-b+bt)
]
]
Both multipliers become smaller
The G multiplier when taxes change
with income (Income Taxes)
The effect of an increase in G is smaller with income taxes
because as income increases, the government taxes a
portion of the increase in income.
DY = DG + DC; DC is smaller than before
The effect of a tax cut is also smaller with income taxes
because as income increases, the government taxes a
portion of the increase in income.
DY = DC; DC is smaller than before
The oversimplified formula
overstates the size of the multiplier
Permanent Tax Cut or Tax
Holiday?
A tax cut has more potential impact in the
long run than a tax holiday.
A payroll tax credit would provide more of a
spending boost since it is a permanent change in
the tax code
Households are more likely to spend a tax
cut if it is the result of a permanent
change rather than a temporary one
Households are more likely to save a
temporary tax cut.
5/23/2017
© 2002 Claudia Garcia-Szekely
43
Open Economy with Government
Condition
G that must be satisfied for
equilibrium:
Y = C + I + G + X-M
Y = C + S + T (Income is
Rest of
World
T
Since:
Firms
NX
G
used toHouseholds
consume, save and pay taxes)
We can rewrite the equilibrium condition as:
S
C + S +CT= C + I + G +X-M
SavingsS+T
must=finance
the
I + G +Investment,
X-M
Total
government’s deficit and the
trade
S+T+Mdeficit.
=I+G+X
Production
leakages I= Injections
S = I + (G – T)+(X-M)
Y > AE
Inventories increase
AE
Y < AE
Inventories fall
Leakages
=
Injections
Y
Equilibrium
I+G+X
I+G+X=S+T+M
Y
below equilibrium
Leakages <
Injections
Y
Equilibrium
Y
above equilibrium
Leakages >
Injections
At
What
Y = is
5,000
3,000
the equilibrium
are inventories
GDP?rising? Falling? Unchanged?
For
Forwhat
whatvalue
valueof
ofGDP
GDPis:
is:
YY==AE?
AE?
For what value of GDP is:
S = I +(G-T) +(X-M)?
I + (G-T) + (X-M)
Automatic Stabilizers
Features of the economy that
reduce its sensitivity to shocks
5/23/2017
© 2002 Claudia Garcia-Szekely
47
Personal Income Taxes
AUTOMATIC STABILIZERS
5/23/2017
© 2002 Claudia Garcia-Szekely
48
1.
Personal Income Taxes
When GDP rises, we earn more income
but we also pay more taxes and thus
consumption does not rise as much as
it would if taxes did not rise with
income.
When GDP falls, we earn less income
but we also pay less taxes and thus
consumption does not fall as much as it
would if taxes did not fall with income.
5/23/2017
© 2002 Claudia Garcia-Szekely
49
Unemployment Compensation, Income supplements for the poor
AUTOMATIC STABILIZERS
5/23/2017
© 2002 Claudia Garcia-Szekely
50
2. Unemployment Compensation, Income
Supplements for the poor
When GDP falls, more people receive
unemployment insurance payments thus
dampening the fall in incomes (and
consumption) that would occur with a
falling GDP.
When GDP rises, fewer people receive
unemployment insurance payments thus
dampening the rise in incomes (and
consumption) that comes with a rising GDP.
5/23/2017
© 2002 Claudia Garcia-Szekely
51
Chart 2-3. The Federal Government Dollar— Where It
Comes From
2008
Discretionary
Spending
Mandatory
Spending
5/23/2017
© 2002 Claudia Garcia-Szekely
53
Fiscal Policy
MPC = 0.9. Find DG/DT necessary to close the gap.
Calculate for each DC, D Deficit.
Fiscal Policy
MPC = 0.9. Find DG/DT necessary to close the gap.
Calculate for each DC, D Deficit.
Effect on C, AE, AD, GDP and
prices
Increase (decrease) in taxes (fixed
or variable)
Increase (decrease) in transfers
Increase (decrease) in G
5/23/2017
© 2002 Claudia Garcia-Szekely
56
Example:
C = 200 +0.8 (Y-T)
I = 300
G = 150
T = 100
Add to get AE
AE = 650 + 0.8 (Y – 100)
AE =650 – 0.8(100) + 0.8Y
AE = 570 + 0.8Y
5/23/2017
© 2002 Claudia Garcia-Szekely
57
Equilibrium Output
AE = 570 + 0.8Y
Set Y = AE and solve for Y:
Y = 570 + 0.8 Y
Y – 0.8Y = 570
Y = 2,850
Y(1-0.8) = 570
Y = 570/0.2
5/23/2017
© 2002 Claudia Garcia-Szekely
58
Equilibrium
C = 200 +0.8 (Y-T)
I = 300
G = 150
T = 100
- 80
AE=2,850
570
5/23/2017
Y=2,850
© 2002 Claudia Garcia-Szekely
59
C = 200 +0.8 (2,850-100)
I = 300
G = 150
T = 100
C = 2,400
AE=2,850
Y=2,850
450
I+G
I+G=S+T
450
S = Y-C-T
S = 2,850 – 2,400-100
Y=2,850
S = 350
+
T = 100