1. Fiscal Policy: Taxes, Spending, and the Federal Budget © 2003 South-Western/Thomson Learning

2. Spending, Taxes, and the Budget When examining budget-related figures over time, it is grossly misleading to use nominal figures, sinceit is grossly misleading to use nominal figures, since the price level rises over time.the price level rises over time.

3. Spending, Taxes, and the Budget Spending and debt should be considered relative to total income. This is why we should always look at these figures as percentages of GDP.

4. Spending, Taxes, and the Budget Government SpendingGovernment Spending Federal Tax RevenuesFederal Tax Revenues The Federal Budget and the National DebtThe Federal Budget and the National Debt

5. Government Spending Three Categories of Government Spending Government PurchasesGovernment Purchases Transfer PaymentsTransfer Payments Interest on the National DebtInterest on the National Debt

6. Government Spending

7. Government Purchases As a percentage of GDP, non-military government purchases have remained very low and stable and have not contributed to growth in total government spending.

8. Government Purchases As a percentage of GDP, military purchases have declined dramatically over the past several decades and have not contributed to any growth in government spending.

9. Government Purchases The decline in military spending in relation to GDP since the early 1960s has made huge amounts of resources available for other purposes.

10. Transfer Payments In recent decades, transfers have been the fastest-growing part of federal government spending and are currently equal to about 8 percent of GDP.

11. Social Security and Other Transfer Payments Retirement Benefits $433 billion Health (Medicare and others) $390 billion Income Security $270 billion

12. Total Government Spending Over the past several decades, and until the early 1990s, federal government spending as a percentage of GDP rose steadily.Over the past several decades, and until the early 1990s, federal government spending as a percentage of GDP rose steadily. The main causes were:The main causes were: – increases in transfer payments –increases in interest on the national debt that exceeded the decreases in military spending.

13. From 1992 to 2000, federal government spending as a percentage of GDP fell steadily.From 1992 to 2000, federal government spending as a percentage of GDP fell steadily. The main causes of the decline have been:The main causes of the decline have been: –continued sharp decreases in military spending –more modest decreases in transfer payments relative to GDP. Total Government Spending

14. Federal Tax Revenues Source Revenue (Billions of Dollars) Personal income taxes994 Social Security taxes694 Corporate income taxes151 Excise taxes66 Other sources 86 Total1,991

15. Personal Income Tax Progressive Tax A tax whose rate increases as income increases

16. Personal Income Tax 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.

17. Social Security Tax The Social Security tax applies to wage and salary income only.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 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.The Social Security tax is actually the largest tax paid by many Americans.

18. Other Federal Taxes Corporate Profits TaxCorporate Profits Tax –Applies only to corporations –Double Taxation Excise TaxesExcise Taxes

19. Federal Revenue as a % of GDP

20. The Federal Budget and the National Debt Deficits - which add to the public’s holding of government bonds - add to the national debt.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.Surpluses - which decrease the public’s bond holdings - subtract from the national debt.

21. The Federal Budget and the National Debt

23. The Effects of Fiscal Changes in the Short Run How Economic Fluctuations Affect the Federal BudgetHow Economic Fluctuations Affect the Federal Budget How the Budget Affects Economic FluctuationsHow the Budget Affects Economic Fluctuations

24. How Economic Fluctuations Affect the Federal Budget In a recession, because transfers rise and tax revenue falls, the federal budget deficit increases (or the surplus decreases).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).In an expansion, because transfers decrease and tax revenue rises, the budget deficit decreases (or the surplus increases).

25. How Economic Fluctuations Affect the Budget Cyclical Deficit The part of the federal budget deficit that varies with the business cycle. 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.

26. How the Budget Affects Economic Fluctuations Many features of the federal tax and transfer systems act as automatic stabilizers.Many features of the federal tax and transfer systems act as automatic stabilizers. As the economy goes into a recession, these featuresAs the economy goes into a recession, these features –help to reduce the decline in consumption spending –also cause the cyclical deficit to rise

27. How the Budget Affects Economic Fluctuations As the economy goes into an expansion, these featuresAs the economy goes into an expansion, these features –help to reduce the rise in consumption spending –also cause the cyclical deficit to fall

28. The Effects of Fiscal Changes in the Long Run Impact of Large and Continuing Budget Deficits Government continually demands loanable funds.Government continually demands loanable funds. Lower investment spending causes the capital stock to grow more slowly.Lower investment spending causes the capital stock to grow more slowly. National debt - and annual interest payments on the national debt - grow.National debt - and annual interest payments on the national debt - grow.

29. The Effects of Fiscal Changes in the Long Run Impact of Large and Continuing Budget Surpluses Government continually supplies loanable funds.Government continually supplies loanable funds. Higher investment spending causes the capital stock to grow more rapidly.Higher investment spending causes the capital stock to grow more rapidly. National debt - and annual interest payments on the national debt - shrink.National debt - and annual interest payments on the national debt - shrink.

30. Is the National Debt Dangerous? 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.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.In this case, the government can continue to pay interest on its rising debt without increasing the average tax rate in the economy.

31. Countercyclical Fiscal Policy Changes in taxes or government spending designed to counteract economic fluctuations

32. Reasons Against Countercyclical Fiscal Policy Timing ProblemsTiming Problems IrreversibilityIrreversibility The Fed’s ReactionThe Fed’s Reaction