UNIT V: FISCAL POLICYWhat can the government
do to help fight the economic enemies of
Recession/Depression and Inflation?
Part I: Fiscal PolicyPart II: TaxesPart III: Debt
Part I: Fiscal Policy
What is fiscal policy?It’s the
government’s power to TAX AND SPEND in order to regulate the economy
The fiscal year runs from October 1 to September 30
Where does fiscal policy come from?
1936: John Maynard Keynes develops his “General Theory” in his book The General Theory of Employment, Interest, and Money.
Why does the actual production in an economy sometimes fall short of its productive capacity?
Thus was born the Keynesian Revolution
2 Ways to be an Economist:
Classical Keynesian
Classical:
Economy will have its ups & downs (a general flow)
Keep gov’t out of business; leave it along
Things will work themselves out…
Keynesian:
John Maynard Keynes said economy was more like an elevator
If elevator is stuck, you need to intervene (emergency buttons?!)
Increase spending to stimulate demand
Who was John Maynard Keynes?
Gov’t advisor, teacher, journalist
Revolutionized economic theory
Influenced wartime and post-war economic policy
New Deal Economics: Demand Side Economics/(Keynesian)
Keynesian vs. Classical Economics
Keynesian Classical
Examines the productive
capacity of the economy as a
wholeNo self-correcting
method!!!!!!!!!The answer:
SPENDFDR agreed!
Examined theequilibrium of
supply and demand forindividual products
Fiscal Policy and Aggregate Demand
Fiscal policy will regulate aggregate demand
What is aggregate demand?
How is aggregate demand calculated? THE TARGET:
AGGREGATE DEMAND
AND/OR….increase or decrease the government’s spending (g)
Demand-Side Economics
Supply-Side Economics
Lower taxes for consumers
which will in turn increase
the purchasing power of the
consumer(Keynesian)
Lower taxes for businesses to
encourage industries to
invest(increases aggregate
supply)
The Government’s Role
Expansionary Contractionary
Increase government
spending or cut taxes to increase
demand
Output Employment
Decrease spending or raise taxes to
decrease or slow demand
Why? When demand exceeds supply, producers must choose between raising output or
raising prices
Type of fiscal policy
Change in government
spending
Change in taxes
Expansionary
And/Or
Contractionary
And/Or
Types of Fiscal Policy
How can we stabilize the economy?
Discretionary StabilizersAutomatic Stabilizers
◦The deliberate manipulation of taxes & gov’t spending by Congress – (government makes/changes laws) Increase/Decreases taxes & spending
Policy change happens by itself as the economy changes
◦Unemployment Compensation
◦Progressive Income Taxes
Discretionary Policies:
I. EXPANSIONARY:◦Why? Jumpstart the economy by stimulating
demand
◦How? Increase gov’t spending Decrease taxes
◦When Used? During a recession
Effects of Expansionary Fiscal Policy
Total output in the economyHigh outputLow output
High prices
Low prices
Pri
ce
le
ve
l
Aggregate supply
Original aggregate demand
Lower output, lower prices
Higher output, higher prices
Aggregate demand with higher government spending
Expansionary Fiscal PoliciesIncreasing Government
Spending If the federal govt
increases its spending or buys more goods & services, it triggers a chain of events that raise output & creates jobs.
Cutting TaxesWhen the govt cuts
taxes, consumers & businesses have more money to spend or invest. This increases demand & output.
CONTRACTIONARY:◦Why?
“cool” down economy Slow down demand
◦How? Decrease spending Increase taxes
◦When? Inflationary Times
Discretionary Policies:
Effects of Contractionary Fiscal Policy
Total output in the economyHigh outputLow output
High prices
Low prices
Pri
ce
le
ve
l
Aggregate supply
Higher output, higher prices
Original aggregate demandLower output,
lower prices
Aggregate demand with lower government spending
Contractionary Fiscal PoliciesDecreasing Government
Spending If the federal govt
spends less, or buys fewer goods & services, it triggers a chain of events that may lead to slower GDP growth.
Raising Taxes If the federal govt
increases taxes, consumers & businesses have fewer dollars to spend or save. This also slows growth of GDP.
The Effectiveness of Fiscal Policy
Objective Policy Condition existing
Does the policy affect
total spending in
the economy?
Does the policy meet the
objective (as stated in the 1st
column)?
Reduce unemploym
ent
Expansionary fiscal
policy (as measured
by an increase in
govt spending)
No crowding
outYES YES
Complete crowding
outNO NO
Incomplete Crowding
outYES YES
Reduce inflation
Contractionary fiscal policy (as measured
by an decrease in
govt spending)
No crowding
inYES YES
Complete crowding
inNO NO
Incomplete Crowding
inYES YES
Part II: Taxes
Why do we pay taxes?
What kinds of taxes are there?
Federal Income Tax (W-2, W-4, etc.)
Excise TaxesEstate TaxesFICACapital Gains
TaxesCorporate
Income Taxes
What is a “Fair Tax”?
1. It is proportional to income
2. It is clear and comprehendible
3. It is economically efficient
4. It is flexible
George W. Bush’s Tax Plan(2001-2010)
Lowered taxes across the board (25-35%)
Eliminated the marriage penalty
Increased yearly IRA contributions
Increased the child credit
MORE DISPOSABLE INCOME!!!
What is the “Flat Tax” Proposal?
Flat tax of 17% on all Americans
No Deductions (except children)
Family of 4 would have to earn $36,800 before income tax
Armey-Shalby Tax: Freedom and Fairness Restoration Act
3 Kinds of Effective Tax Rates
-Progressive Tax: tax rate increases as a person’s income goes up (income tax)
Proportional Tax: tax rate remains the same regardless of income (FICA)
Regressive Tax: tax rate “decreases” as income goes up. (Larger proportions of earnings come from people with lower incomes)
Effective Tax Rate: The % of your income you pay in
taxes
Engels LawErnst Engel, German Statistician
The lower a family’s income, the greater the % the family has to spend on the necessities of life.
Proportional taxes are a burden to lower income families
Part III: Budgets, Deficits, and Surpluses
Why would we spend money we don’t have?
War today = Freedom tomorrowInterest rates on U.S. savings bonds,
Treasuries, etc. go back to Americans-for the most part
Multiplier Effect! Expansion = More Expansion
Technology for future (AJH 2013)It is part of our social obligation to
take care of the less fortunate (Medicare, Medicaid, Head Start, etc.
Why should we avoid deficit spending?
Passing on the debt to future generations
It fuels inflationNational Security Risk: 47% of
our national debt is owed to foreigners
Deficit spending increases our national debt
13 cents/$1.00 goes to paying off the interest on our national debt!
What is the national debt?National debt is the
accumulated deficits that add up over the years
Why the Government has a dilemma…
Policies that are put into place to bring down inflation will also increase unemployment
The Phillips Curve?Why is lowering inflation problematic for achieving our economic goals?
Who pays for the cost of running the government?
Budget Levels:1.Federal (U.S.)2.State 3.Local
1.All levels must develop budgets with taxes and spending in mind.
Budget TermsSurplus Budget: revenues exceed expenditures
Deficit Budget: expenditures exceed revenues
Fiscal Year: October 1 - September 30th
How do budgets get “bloated”?“Earmarks” – many
Congressional representatives hold major revenue bills hostage with “earmarks” for their home districts
“Pork Barrel Legislation”
What if the deficit starts going down?
BE WORRIED!!!!!!!!78 Millions Baby Boomers will soon need:
- Social Security -Medicare -Medicare will pay more this year than it
will take in-Social Security will pay out more than it
takes in 2017
Historical Efforts to Cut the Budget
Gramm-Rudman Hollings Act
Balance Budget Amendment
(1995)Limit deficit to
$100 bil in 1990Limit deficit to
$64 bil in 1991Limit deficit to
$28 bil in 1992Balance budget
by 1993
Required federal budgets to be balanced before they became law
Failed by one vote in the Senate
Who prepares the Budget?OMB: Office of
Management and Budget in Executive Office
Congress has the final say
Most likely, the budget that gets passed will be very different from the one the president proposed.
The Federal Budget
Q: What is the single largest federal expenditure?
A: Entitlement Programs
Q: What is the largest single source of revenue?
A: Federal Income Tax
The State Budget
Q: What is the largest source of revenue for the state?
A: Sales Tax
Q: What is the largest expenditure on the state level?
A: Education (Social Security is #2)
The Local Budget
Q: What is the largest source of revenue on the local level?
A: Property Taxes
Q: What is the largest expenditure on the local level?
A: School Budget