1. Ch. 14: Fiscal Policy
Federal budget process and recent history of outlays, tax revenues, deficits, and debts
Supply-Side Economics
Controversies on effects of deficits on investment, saving, and economic growth
Redistribution of benefits and costs across generations
Fiscal policy as a stabilization tool

2. Federal government spending for 2009 (ending in September 2009) is projected to be approximately
$500 billion
$1 trillion
$2 trillion
$3 trillion 20

3. In fiscal year 2009, the budget deficit is projected to be
$500 billion
$750billion
$1 trillion
$1.75 trillion 20

4. The Federal Budget and Fiscal Policy
annual statement of the federal government’s outlays and tax revenues.
Two purposes
finance the activities of the federal government
achieve macroeconomic objectives
Fiscal policy
the use of the federal budget to achieve macroeconomic objectives
Employment Act of 1946
it is the continuing policy and responsibility of the Federal Government to use all practicable means to coordinate and utilize all its plans, functions, and resources to promote maximum employment, production, and purchasing power.

5. Timeline for Budget Process
February to March  President submits budget request to Congress.
May-August:
House and Senate revise/amend proposals
September  House-Senate conference committees resolve differences and agree on final versions of spending bills. President signs or vetoes final bills.
October 1  Beginning of fiscal year.
Congress passes continuing resolutions to maintain funding for any agencies affected by appropriations bills that have not been passed and signed by the beginning of the fiscal year.

6. The Council of Economic Advisers
Fiscal Policy
The Council of Economic Advisers
Chaired by Christina Romer
monitors the economy
keeps the President and the public well informed about the current state of the economy
forecasts of where it is heading.
source of data that informs the budget-making process.
Congressional Budget Office
Forecasts effects of legislative changes on budget and economy

7. Federal Government Revenues

8. Federal Government Spending

10. Federal Deficits and Public Debt
Budgett = revenuet –outlayst
if Budgett > 0  budget surplus
if Budgett < 0  budget deficit
Debtt = Debtt-1 - budgett-1
Budget deficits increase debt
Budget surpluses decrease debt
The national debt clock

11. The Federal Budget

12. CBO PROJECTIONS OF OBAMA BUDGET

13. SOURCE: http://www. cbo

14. The National Debt

16. State and Local Budgets
The total government sector includes state and local governments as well as the federal government.
In 2008, when federal government outlays were about $3,200 billion, state and local outlays were a further $2,000 billion.
Most of state expenditures were on public schools, colleges, and universities ($550 billion); local police and fire services; and roads.
Most states have “balanced budget amendments”.

17. Supply-Side Economics
Fiscal policy aimed at increasing LAS
Income taxes affect LAS by affecting labor supply.
Higher income taxes reduce labor supply & reduce LAS
“Supply-siders” argue for low marginal tax rates.
Graph the effect of an increase in income tax rate on
before-tax real wage rate, after-tax real wage rate.
Tax-wedge
Equilibrium employment
LAS

18. Effect of an increase in income tax rate

19. Tax Wedge Comparisons

20. In 2008, a single person with $10,000 of taxable income would pay federal income taxes of:
$542
$937
$1526
$1924 20

21. In 2008, a single person with $100,000 of taxable income would pay federal income taxes of:
$9,371
$14,268
$17,372
$21,978 20

22. In 2008, a single person with $1,000,000 of taxable income would pay federal income taxes of:
$221,365
$328,597
$416,317
$527,102 20

23. Federal Income Tax Marginal Rates
For recent tax rate schedules and a tax calculator, see:

24. Top Marginal Tax Rates
Source:

25. Historical average tax rates in U. S
Historical average tax rates in U.S. by Income Quintile: Income Tax Only .:
Source:
Includes individual income tax only

26. “The lucky duckies” WSJ, November 2003.
The most recent data from the IRS, in 2000, show that the top 5% coughed up more than half of total tax revenue. Specifically, we are talking about folks with adjusted gross incomes of $128,336 and higher being responsible for 56% of the tax take. Eyebrows raised? There's more. The top 50% of taxpayers accounted for almost all income tax revenue--96% of the total take.
Source:

27. Share of Federal Income Taxes Paid by Quintile.:
Source:
Includes individual income tax only

28. The Supply-Side: The Laffer Curve.
Tax Revenue
Tax Rates

29. As tax rates rise, taxable income may fall because
The Laffer Curve
As tax rates rise, taxable income may fall because
People reduce work hours
Tax avoidance increases
Legal tax avoidance
Charities
Tax free bonds
Pension saving
Etc
Illegal tax avoidance
Under-report income
Inflate deductions

30. Laffer Curve and Capital Gains Tax
Source:

31. According to the Laffer curve, if tax rates rise, tax revenue
Will rise
May rise or fall
Will fall 20

32. The Supply-Side: Investment and Saving
GDP = C + I + G + (X – M)
GDP = C + S + T
 I + G + (X – M) = S + T
I = S + (T – G) + (M – X)
Private saving PS = S + (M – X)
Government Saving GS=T-G
 I = PS + GS

33. The Supply-Side: Investment and Saving

34. The Supply-Side: Investment and Saving
Fiscal policy influences investment and saving in two ways:
Taxes affect the incentive to save and change the supply of loanable funds.
Government saving is a component of total saving and the supply of loanable funds.

35. The Supply-Side: Investment and Saving
A tax on capital income decreases the supply of loanable funds
a tax wedge is driven between the interest rate and the after-tax interest rate
Investment and saving decrease.

36. The Supply-Side: Investment and Saving
Effect of a government budget deficit on saving and investment -- crowding out

37. The Supply-Side: Investment and Saving
Ricardo-Barro Equivalence
In above diagram, it is assumed that government budget does not shift PSLF curve.
Ricardo-Barro:
Larger deficits cause households to increase savings in order to cover future tax increases.
Net effect of larger deficit on SLF curve is zero because PSLF curve shifts right.
No effect on investment or interest rates
All increases in deficits are offset by increased saving (decreased consumption).

38. Higher; more Higher; less Lower; more Lower; less
Assume that deficits do not affect private saving. A larger budget deficit will lead to ___ interest rates and ___ investment
Higher; more
Higher; less
Lower; more
Lower; less 20

39. No change in; higher; less More; no change in; no change in.
Assuming Ricardo-Barro effects, an increase in the federal budget deficit will lead to ___ private saving, ___ interest rates, and ____ investment.
No change in; higher; less
More; no change in; no change in.
More; lower; more.
None of the above 20

40. Stabilizing the Business Cycle
Discretionary fiscal policy
action that is initiated by an act of Congress.
Automatic fiscal policy (Auto stabilizers)
fiscal policy triggered by the state of the economy.

41. Stabilizing the Business Cycle
Discretionary Fiscal Stabilization
An increase in government expenditure or a tax cut increases aggregate demand.
The “multiplier process” increases aggregate demand further.
Size of multiplier is controversial.

42. Stabilizing the Business Cycle
A decrease in government expenditure or a tax increase decreases aggregate demand.
The multiplier process decreases aggregate demand further.

43. Stabilizing the Business Cycle
Limitations of Discretionary Fiscal Policy
Recognition lag
time it takes to figure out that fiscal policy action is needed.
Law-making lag
time it takes Congress to pass the laws needed to change taxes or spending.
Impact lag
time it takes from passing a tax or spending change to its effect on real GDP being felt.

44. Stabilizing the Business Cycle
Automatic Stabilizers
mechanisms that stabilize real GDP without explicit action by the government.
Taxes that rise and fall with GDP taxes and needs-tested spending are automatic stabilizers.
When real GDP decreases in a recession
wages and profits fall, so taxes fall
Needs-tested spending rises
Budget deficit grows (surplus shrinks)

45. The Budget and the Business Cycle
Cyclical and Structural Balances
Actual Budget = Cyclical Budget + Structural Budget
The structural surplus or deficit
the surplus or deficit that would occur if the economy were at full employment and real GDP were equal to potential GDP.
The cyclical surplus or deficit
the surplus or deficit that occurs purely because real GDP does not equal potential GDP.
Cyclical budget < 0 if GDP< potential GDP

47. Cyclical and Structural Budget

49. there would be a surplus There would be a deficit.
If the structural budget is +$100 billion and the cyclical budget is -$300 billion, we can conclude that if the economy was at full employment:
there would be a surplus
There would be a deficit.
There would be a balanced budget. 20

50. If the structural budget is +$100 billion and the cyclical budget is -$300 billion, we can conclude that the economy is currently producing ____ potential GDP
above
below at 20

51. As the economy recovers from the current recession, the actual budget deficit should
Shrink as tax revenues rise and government spending falls
Shrink as tax revenues and government spending fall
Rise as tax revenues rise and government spending falls.
None of the above. 20