Download Economics: Principles and Applications, 2e by Robert E. Hall & Marc

Economics: Principles and
Applications, 2e
by Robert E. Hall &
Marc Lieberman
© 2001 South-Western, a division of Thomson Learning
Fiscal Policy:
Taxes, Spending,
and the Federal Budget
© 2001 South-Western, a division of Thomson Learning
Thinking About Spending,
Taxes, and the Budget
When examining budget-related figures over
time, it is grossly misleading to use nominal
figures, since the price level rises over time.
© 2001 South-Western, a division of Thomson Learning
Thinking About Spending,
Taxes, and the Budget
Budget-related figures such as government
spending or the national debt should be considered
relative to a nation’s total income. This is why we
should always look at these figures as percentages
of GDP.
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
•Government Spending
•Federal Tax Revenues
•The Federal Budget and the National Debt
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
Three Categories of Government Spending
•Government Purchases
•Transfer Payments
•Interest on the National Debt
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
As a percentage of GDP, non-military
government purchases have remained very
low and stable. They have not contributed to
growth in total government spending.
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
As a percentage of GDP, military purchases
have declined dramatically over the past
several decades. They have not contributed to
any growth in government spending.
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
The decline in military spending in relation to
GDP since the early 1960s has made huge
amounts of resources available for other
purposes.
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
In recent decades, transfers have been the
fastest-growing part of federal government
spending and are currently equal to about 8
percent of GDP.
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
Over the past several decades, and until the early 1990s,
federal government spending as a percentage of GDP rose
steadily. The main causes were increases in transfer
payments and increases in interest on the national debt
that exceeded the decreases in military spending.
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
From 1992 to 1999, federal government spending as a
percentage of GDP fell steadily, although it remained a
higher percentage of GDP than in 1959. The main causes
of the decline have been the continued sharp decreases in
military spending and more modest decreases in transfer
payments relative to GDP.
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
Progressive Tax
A tax whose rate increases as income
increases.
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
Average Tax Rate
The fraction of a given income paid in taxes.
Marginal Tax Rate
The fraction of an additional dollar of income paid in
taxes.
Spending, Taxes, and the
Budget: Some Background
The Social Security tax applies to wage and salary
income only. The current tax rate is a flat 15.3
percent, subject to a salary cap. The Social Security
tax is actually the largest tax paid by many
Americans.
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
Issues Regarding Other Federal Taxes
•Corporate Profits Tax
•Double Taxation
•Excise Taxes
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
Federal revenue has trended upward from
around 17 percent of GDP in 1959 to around
20 percent in 1999.
© 2001 South-Western, a division of Thomson Learning
Spending, Taxes, and the
Budget: Some Background
Deficits--which add to the public’s holding of
government bonds--add to the national debt.
Surpluses--which decrease the public’s bond
holdings--subtract from the national debt.
© 2001 South-Western, a division of Thomson Learning
The Effects of Fiscal
Changes in the Short Run
•How Economic Fluctuations Affect
Spending, Taxes, and the Federal Budget
•Countercyclical Fiscal Policy?
© 2001 South-Western, a division of Thomson Learning
The Effects of Fiscal
Changes in the Short Run
In a recession, because transfers rise and tax
revenue falls, the federal budget deficit increases (or
the surplus decreases). In an expansion, because
transfers decrease and tax revenue rises, the budget
deficit decreases (or the surplus increases).
© 2001 South-Western, a division of Thomson Learning
The Effects of Fiscal
Changes in the Short Run
Cyclical Deficit
The part of the federal budget deficit that varies with the
business cycle.
Structural Deficit
The part of the federal budget deficit that is independent
of the business cycle.
© 2001 South-Western, a division of Thomson Learning
The Effects of Fiscal
Changes in the Short Run
Many features of the federal tax and transfer
systems act as automatic stabilizers. As the
economy goes into a recession, these features help
to reduce the decline in consumption spending, and
they also cause the cyclical deficit to rise.
© 2001 South-Western, a division of Thomson Learning
The Effects of Fiscal
Changes in the Short Run
As the economy goes into an expansion, these
features help to reduce the rise in
consumption spending, and they also cause
the cyclical deficit to fall.
© 2001 South-Western, a division of Thomson Learning
The Effects of Fiscal
Changes in the Short Run
Countercyclical Fiscal Policy
Changes in taxes or government spending
designed to counteract economic fluctuations.
© 2001 South-Western, a division of Thomson Learning
The Effects of Fiscal
Changes in the Short Run
Reasons Against Countercyclical Fiscal Policy
•Timing Problems
•Irreversibility
•The Fed’s Reaction
© 2001 South-Western, a division of Thomson Learning
The Effects of Fiscal
Changes in the Long Run
Impact of Large and Continuing Budget Deficits
•Government continually demands loanable funds.
•Lower investment spending causes the capital stock to
grow more slowly.
•National debt--and annual interest payments on the
national debt--grow.
© 2001 South-Western, a division of Thomson Learning
The Effects of Fiscal
Changes in the Long Run
Impact of Large and Continuing Budget Surpluses
•Government continually supplies loanable funds.
•Higher investment spending causes the capital stock to
grow more rapidly.
•National debt--and annual interest payments on the
national debt--shrink.
© 2001 South-Western, a division of Thomson Learning
Were We Headed
for a Debt Disaster?
As long as the debt grows by the same percentage as
nominal GDP, the ratios of debt to GDP and interest
payments 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.
© 2001 South-Western, a division of Thomson Learning