Fiscal Policy

1. Fiscal Policy Budget, Taxing, and Spending

2. Fiscal Policy • Government has a major influence in macro-economic policy. • 2010= $2.1 Trillion received (Revenue) • 2010= $3.5 Trillion spent (Expenditures) • Fiscal Policy is the method of taxing and spending used by the Government to help reach our macroeconomic goals. • Fiscal Policy Tools: • Spending • Taxing

3. Government Spending • How does the Government spend $3.5 Trillion?

4. Government Revenue How does the Government collect its revenue?

5. How does the Government collect its revenue? • Federal- Income Tax, Corporate Income Tax, Estate Tax, Gift Tax, Tariffs • State- Sales Tax, Income Tax, State Fees and Registrations, State Lottery • Local- Property Taxes, Local (City, County, or Township) Fees

6. Tax Structures • Progressive Taxes- Tax structure where the percentage paid in taxes increases as income increases. • Ex. Income Tax • Regressive Taxes- Tax structure where the percentage paid in taxes decreases as income increases. • Ex. Sales Tax • Proportional Tax- Tax structure where the percentage paid in taxes is the same for all income levels. • Ex. Flat Tax

7. Federal Income Tax Brackets-2011 (Progressive Tax)

8. How are income taxes collected? • April 15 • Report income from employers (1040 form), the 1040 form helps taxpayers find out their taxable income. • Taxable income= Gross income- exemptions and deductions • IRS determines how much you have paid in taxes and how much you owe, or overpaid. • The amount that an individual owes is dependent upon their taxable income.

9. How does the government determine how to spend its money? Budget Process- Surplus, Deficit, or Balanced • Office of Management and Budget (OMB) • Works with the President to put together a draft of the budget. • Congress • Reviews the budget draft and makes changes • President • Signs the budget or Veto’s the budget

10. Government Spending • Discretionary vs. Mandatory • Discretionary- Money that policymakers get to decide on how or how much to spend. • Ex. Defense, Education, Environmental Research, Foreign Aid • Mandatory- Money that is determined by law to fund certain programs or Government functions. • Ex. Social Security, Medicare, Medicaid, Interest on Debt

11. Fiscal Policy • Expansionary vs. Contractionary • Expansionary Policy- Increase Spending, Decrease Taxes, Increase in Government Transfers • Used to Stimulate the economy during a recession • Contractionary Policy- Decrease Spending, Increase Taxes, Decrease in Government Transfers • Used to slow growth during an inflationary BOOM

12. Impact of Fiscal Policy • Government Spending Multiplier= 1/mps, this gives us the max that an increase in spending can boost GDP. • Tax Multiplier= mpc/mps, this gives us the max that a decrease in taxes can boost GDP. • Why is the Tax Multiplier smaller than the Spending Multiplier?

13. Practice Problem: • a. Draw a correctly labeled graph showing an economy experiencing a recessionary gap. • b. What type of fiscal policy is appropriate in this situation? • c. Give an example of what the government could do to implement the type of policy you listed in part b. • d. GDP is $200 billion below potential output, how much would the Government have to cut taxes with a MPC=.8, to bring the economy to full-employment?

14. Built-in or Automatic Stabilizers • Programs that automatically help to counter-act cyclical change in the economy without any legislative action. • Unemployment Compensation • Corporate Profit Tax • Progressive Income Tax • What is happening with these programs during a recessionary gap or inflationary gap?

15. Built-in or Automatic Stabilizers • As GDP Changes: • The automatic stabilizers change… • Progressive Income Tax- decreases as GDP decreases… • And increases as GDP increases • The Effects: • This automatic change will slow down an economy in expansion, and stimulate an economy in recession.

16. Advantages of Automatic Stabilizers • No legislative action… enough said! • Timing is everything: • Policy lag is the delay that it takes for a policy to start impacting the economy. • Forecasting lag is the delay that it takes for policymakers to figure out what policy to implement.

17. Discretionary Fiscal Policy • Fiscal Policy that is changed by policymakers when the business cycles change. • What can policymakers change? • Education, Military, Agriculture, Transportation • When would discretionary fiscal policy be used?

18. Implications with Fiscal Policy • Proper Timing of discretionary spending is both difficult to achieve and crucially important. • Good Timing= Properly stabilized business cycle change • Bad Timing= Unnecessary business cycle fluctuation • Automatic Stabilizers help to balance the economy without legislative action, but they lack any potency to rectify a severely struggling economy. • Fiscal policy doesn’t impact the economy as much as initially presumed. • Lessened Multiplier Effect

19. Political Considerations of Fiscal Policy: • Fiscal policy is created in a political arena • What problems could this cause? • Politicians have an agenda that doesn’t always match the need of the economy. • Politicians are worried about getting elected, and certain fiscal policy options are not popular with the public.

20. Long Run Implications of Fiscal Policy • Budget Surplus vs. Budget Deficit • Surplus= Contractionary Policy • Deficit= Expansionary Policy • Should the budget be balanced? • Problems of prolonged deficits: • Increased Public or National Debt • Problems with a forced balanced budget: • Lessens impact of fiscal policy ability

21. Long Run Implications of Fiscal Policy • Problems with the rising National Debt: • Crowding Out Effect: • As the Gov. borrows money, it pushes up interest rates and discourages or crowds out business investment. • Show Loanable Funds Market Graph • Also, as our public debt increases more of our government spending is needed to pay back interest on our debt. • The payments on the interest limit the gov.’ s ability to spend on other needed areas.