Download Fiscal Policy, the Budget, and the National Debt

Fiscal Policy, the Budget,
and the National Debt
Fiscal Policy -- the Federal
government changing its
government position (G - T) in
order to stabilize the economy.
The Federal Budget
Budget = Tax Revenues Government Expenditure
(over a given period)
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 Federal Budget: 2001
(Billions of Dollars)
Tax Revenues = $2008.4
Government Expenditure =
$1936.4
Budget = $72.0
Source: Economic Indicators,
September 2002
Breakdown of
Tax Revenues
Personal Income Taxes = $1010.9
Corporate Profits Taxes = $170.2
Indirect Business Taxes = $110.3
Contributions for
Social Insurance = $716.9
Breakdown of
Government Expenditure
Purchases of Goods and Services (G)
= $528.4
Transfer Payments
= $842.2
Grants-in-aid to State
and Local Governments = $277.4
Net Interest Paid
= $238.1
Net Subsidies of
Gov’t Enterprises
= $50.3
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.
Expanded by deficits, reduced by
surpluses
National Debt -Realistic Goal
Realistic Goal -- consider the
Debt-Income Ratio =
(National Debt)/(GDP).
Consumers are allowed a DebtIncome Ratio maximum of 2.0.
For the US in 2001 =
($3320.1)/($10208.1) = 0.325
Conclusion – National Debt in US
not a major concern.
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 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 Rate (t)
-- Expansionary: t
-- Contractionary: t
Change Autonomous Net Taxes
(T0) – taxes that don’t depend upon
income (e.g. sales taxes).
-- Expansionary: T0
-- Contractionary: T0
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).
Less growth in investment  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
A Benefit of
Government Debt Reduction
Consider the “Crowding Out
Effect” in reverse.
Suppose that the government runs
a budget surplus and uses it to
reduce the national debt.
Supply for financial capital shifts
rightward, r* decreases and I*
increases.
Cushions some of the contraction,
enhances economic growth.
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 Cut of 2001-02?