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Fiscal Policy Government action to influence the economy Reference 15.1 Fiscal Policy • Expansionary: Increase total spending to reduce unemployment • Contractionary: Reduce total spending to reduce inflation Expansionary Fiscal Policy • The government can decide to: 1. Increase government spending 2. Lower taxes 3. Do both Will this policy achieve its goal???? maybe… • Will additional government spending “crowd out” private spending? • Example: An additional $2,000,000 dollars spent on education by government may result in consumers spending $2,000,000 less on private school tuition. • A Comparison: “Harry Potter” John Maynard Keynes The General Theory of Employment, Interest, and Money • 1883-1946 • Revolutionizes thinking about the government’s role in the economy. – Influential to the “New Deal” • Argued for expansionary fiscal policy in times of recession or depression Contractionary Fiscal Policy • The government can decide to: 1. Reduce government spending 2. Increase taxes 3. Do both NOT VERY POPULAR…But will it work? maybe… • Will private spending “crowd in”? Will consumers spend more when faced with less government spending? • Example: The schools are so under-funded that parents spend money to put their kids in private schools. How Taxes Can Affect Spending • After-tax income: what you have left to spend after you’ve paid income taxes. • Higher after-tax income increases demand (expansionary) low tax rate • Lower after-tax income decreases demand (contractionary) high tax rate How Taxes Can Affect Supply • If you were taxed at 100%, would you work? • High tax rates can reduce productivity Tax Rates ….Tax Revenues • Will higher tax rates give the government greater tax revenues? • Will lower tax rates give the government smaller tax revenues? Only if INCOME is constant. Laffer Curve • controversial theory • created by economist Arthur Laffer • represents the relationship between tax rates and tax revenues. • What is the ideal tax rate? Review • What is expansionary fiscal policy, and for what purpose is it likely to be implemented? • What is contractionary fiscal policy, and for what purpose is it likely to be implemented? Review • Is expansionary fiscal policy always effective at increasing total spending and decreasing unemployment? • Explain your answer? Review • Someone says, “If the federal government cut income tax rates, tax revenues will rise.” Might this person be wrong? Explain your answer. Homework • Read and note Ch. 16.1 “Taxes” pages 418-430. • Complete Section Review p. 430 #2-4 • Current Issue: How will the repeal of the Bush tax cuts affect the economy?