Download Claudia Pasantes

Period 5 Claudia Pasantes Mariam Ali Maecel Manzano Sara-Shae Lewis
PG. 229-230
Built in Stability
 Government tax revenues change automatically per course of business cycle to
stabilize economy.
→ nondiscretionary (passive or automatic
 Budgetary policy- results from makeup of most tax system
→NET TAX revenues vary directly with GDP
tax revenues (less transfers and subsidies)
 ANY TAX will yield more government revenue as GDP rises.
Personal Income Taxes
 Have progressive rates
 Generate more than proportionate increase in tax revenue as GDP expands.
 As GDP increases, Taxes from revenues sold, sales taxes and excise taxes also
increase (direct relationship)
 Economic expansion creates more jobs!
Transfer Payments (negative taxes)
 Behave in opposite way from tax revenues
What decreases during economic expansion and increase during economic contraction
 Unemployment compensation payments
 Welfare payments
 Subsidies to farmers
Automatic or Built in Stabilizers
Built in Stabilizer: anything that increases the government’s budget deficit during
recession and increases its budget surplus during inflation without requiring explicit
action by policymakers.
In the graph on page 229, Line T represents the direct relationships between tax revenues
and GDP.
Economic Importance:
 Taxes reduce spending and aggregate demand
 Reductions in spending are desirable when the economy is moving toward
inflation, whereas increases in spending are desirable when the economy is
slumping.
Econ Importance cont.
 Taxes increase automatically increase as GDP rises during prosperity.
 As economy moves towards higher GDP, Tax revenues increase (direct
relationship)
Tax Progressivity
 Size of the automatic budget deficits or surpluses depends on the responsiveness
of tax revenues to changes in GDP
 Steepness of Taxes depends on tax system itself.
-Proportional Tax System: average tax rate remains constant as GDP rises.
-Regressive Tax System: average tax rate falls as GDP rises.
-Progressive Tax System: average tax rate rises with GDP.
-the more progressive the tax system, the greater the economy’s built in stability.
-progressivity of tax system affect degree of built in stability.
-Built in Stability provided by U.S tax system has reduced severity of business
fluctuations.
-only diminish NOT eliminate savings in real GDP
-discretionary fiscal policy (changes in tax rates and expenditures) or
- monetary policy (central bank- caused changes in interest rates needed to
correct recession or inflation.
Evaluating fiscal policy
-To evaluate fiscal policy you must adjust deficit and surplus to eliminate
automatic changes in tax revenue budgets.
-Compare size of adjusted budget deficits (or surpluses)
Economists use the full employment budget (standardized budget)
-Full employment budget is used
to adjust the actual federal budget
deficits/surpluses to eliminate the automatic changes in tax revenues
-Full employment budget measures what the federal budget deficit/surplus
would be with existing tax rates and government spending levels if the
economy had achieved its full employment level of GDP in each year.
Government's budget deficit equal s the tax revenues forthcoming at the fullemployment output
Full-employment budget also called standardized budget is used to adjust the
federal budget
$500 billion of government expenditures in year 2 are shown by B on line G
and shown on line T. Both A and B represent the equilibrium in year 2 and year
1 graph. In graph #2 there is a $25 billion tax return revenues by which B is the
full employment.
Group 3
DID NOT EMAIL
Pages 233-238
Problems of timing
Recognition lag
- Time between beginning of recession or inflation
- Happens b/c of difficulty in predicting future course of economic
activity
- Index of leading indicators do help, but economy could be in
recession already
Administrative Lag
- Lag in time needed for fiscal action being recognized and time
of action taken
- Sometimes congress takes so long that economic situation has
already changed, so the policy action is not appropriate
Operational lag
- Lag between time of fiscal action is taken vs. time the action
affects output, employment, or price level
- New govt spending requires long planning and construction
- Fiscal policy has relied on fax changes in spending
Graphical Presentation
- Aggregate supply curve here has no real world intermediate
range. At full capacity the price level is constant. After economy
reaches full capacity the vertical range of AS prevails, so any
additional increase in aggregate demand would be purely
inflationary.
- If govt. Enacts an expansionary fiscal policy that shifts the AD
curve rightward, the economy will achieve full capacity cut
with out inflation. With no offsetting or complicating factors,
this “pure and simple” expansionary fiscal policy moves the
economy from recession to its full capacity.
- The crowding out effect may greatly weaken expansionary
fiscal policy.
Net Export Effect
- Net Export effect may also work through international trade to
reduce the effectiveness of fiscal policy
- We know that an increase in demand for a product causes its
price to rise. So the price of dollars rises in terms of foreign
currencies.
Crowding-Out Effect
- an expansionary fiscal policy will increase the interest rate and
reduce private spending, thereby weakening or concealing the
stimulus of the expansionary policy.
- Investment spending varies inversely with the interest rate.
Criticism of Crowding Out-Effect
- Increase in G, Increase in C resulting from tax cuts will likely
improve profit expectations for businesses.
- Can counteract crowding out by Increase in supply money to
offset deficit, caused by demand for money
- Equilibrium interest rate = crowding out at 0
Fiscal Policy, Aggregate, Supply, and Inflation
- Aggregate supply complicates fiscal policy
- When aggregates slopes upward = higher prices
- May cause inflation along with declines in unemployment and
increases in GDP
Shocks originating from Abroad
- Policies abroad effect a nation’s net ex and affects own
economy
- National econ. Vulnerable to AD shock; can alter GDP and make
current domestic fiscal policy inappropriate
- If congress enacted expansionary Fiscal policy to increase GDP
and AD without igniting inflation. Economies of major trading
partners of the US unexpected expansion, they buy more
American Goods fiscal policy becomes too expansionary.
Supply Side Fiscal policy
- Supply side fiscal policy or tax changes, alter aggregate supply
and affect results of a change in fiscal policy
- Supply side fiscal policy helps the economy by tax reductions
shift the aggregate supply curve to the right, reduces inflation
and increases economic growth
- 3 reasons for the supply side effect
1. saving and investment- lower taxes increases savings and
DI
2. work incentives- people get more of their money so they
want to work more.
3. Risk taking- lower taxes increase businesses and
entrepreneurs to invest more in new methods and new
products
Mainstream skepticism
- govt should consider potential aggregate supply effects when
formulating its discretionary fiscal policy
Austin “Thersa” Cruz is the greatest