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Fiscal Policy © 2010, TESCCC
Fiscal Policy Defined The government’s (Congress and the President) use of taxing and spending to promote economic growth and stability © 2010, TESCCC
History of Fiscal PolicyLaissez-faire (classical economics) The Great Depression 1929 – 1930’s WWII No need for government interference Market regulates itself Adam Smith, David Ricardo, Thomas Malthus are classical economists Challenged classical economics FDR increased government spending on programs to increase employment on public works to help stop the depression To prepare for war, U.S. increased production of war goods. Government spending increased dramatically which helped the country out of the depression. © 2010, TESCCC
History of Fiscal PolicyJFK proposed tax cuts to personal and business income taxes to increase aggregate demand. Government spending increased due to the Vietnam War. Reagan passed a bill to reduce taxes by 25% over 3 years to fight stagflation (high unemployment + high inflation). Demand-side policies would not work, thus supply-side policies were introduced – known as Reaganomics. © 2010, TESCCC
Two Branches of Fiscal Policy:Demand-side Supply-side © 2010, TESCCC
Demand-Side EconomicsInspired by John Maynard Keynes during the Great Depression and is also called Keynesian Fiscal Policy Looks at changing aggregate demand which is either increasing or decreasing © 2010, TESCCC
Tools of Fiscal Policy 1. Taxing Policy of Government2. Spending Policy of Government © 2010, TESCCC
Aggregate Demand is C + I + G + (F) = GDPChanges in business (I) spending is the most volatile and this will cause the most economic instability. To offset this, the government can compensate by changing their taxing and spending to maintain a stable level of GDP. © 2010, TESCCC
Demand-Side Fiscal PolicyKeynes said that sometimes the market could not correct itself and the government needs to take a more active role in the economy. This increased role of government in the economy was something different from the classical view. It was considered very radical for the time. © 2010, TESCCC
Limitations of Demand-Side Fiscal PolicyNot coordinated with monetary policy Surplus budget unpopular and politicians lack the political will to carry it out Time lags - inside lags and outside lags People are unpredictable. Economics is a social science so we are dealing with human behavior. Doesn’t solve stagflation © 2010, TESCCC
Multiplier Effect The multiplier effect in fiscal policy states that for every one dollar change in taxing or government spending, it will create a greater change in the national income, either increasing or decreasing. © 2010, TESCCC
Fiscal Policy – Supply-Side© 2010, TESCCC
Supply-Side Fiscal PolicyEconomic policies designed to stimulate output (GDP) and lower unemployment. To achieve this you increase aggregate supply (AS). Contemporary supply-side was implemented in the 1980’s to deal with stagflation and is sometimes called “Reaganomics.” Goal is to give incentives to businesses to produce more ( AS). © 2010, TESCCC
Principles of Supply SideTax cuts encourage consumers to save so businesses have money to borrow for capital investment. Government spending cuts especially on transfer payments where nothing is produced Deregulate business Overall Less Government © 2010, TESCCC
PL When AS increases - increase GDP Q AS1 AS2 AD Q1 GDP Q2© 2010, TESCCC
PL When AS increases - price goes down Q AS1 AS2 P1 P2 AD© 2010, TESCCC
Supply-Side EconomicsStresses the influence of taxation on the economy. Supply-siders believe that taxes have a strong, negative influence on output. Arthur Laffer came up with a theory concerning tax rates and tax revenues. It was called the Laffer Curve. Laffer said if you lower the tax rate, we will see an increase in tax revenue. © 2010, TESCCC
Laffer Curve A Tax 100% B R a t es C D E 0% Tax Revenues© 2010, TESCCC
Laffer Curve 100% Govt. will collect no revenue at two tax rates, 0% and 100%. With 100% tax rate, workers lose all incentive to work (no disposable personal income) and at 0% tax rate the government will collect 0 revenue. Tax R a t es 0% Tax Revenues © 2010, TESCCC
Laffer Curve 100% A B Tax R a t es As we move from A to B, tax rate is lowered and we increase tax revenue. C D E 0% Tax Revenues © 2010, TESCCC
Laffer Curve 100% Point C is the optimum tax rate. Higher tax rates decrease worker incentives. Below C we decrease the revenue. PROBLEM: We don’t know where we are on the curve. Tax R a t es C 0% Tax Revenues © 2010, TESCCC
Limitations Lack of experience - hasn’t been around long enoughDon’t know where we are on Laffer Curve Makes Federal Income Tax less progressive and reduces the automatic stabilization and reduces many “safety net” programs © 2010, TESCCC
Deciding Fiscal policyTaxing & Spending Deciding Fiscal policy © 2010, TESCCC
When the U.S. Government decides Fiscal Policy:They are deciding which goal to address at a given time – economic growth, stability or full employment. They must decide to tax or spend to address the problems in the economy. © 2010, TESCCC
Taxation Power to Tax – Article 1, Section 8, Clause 1 of the U.S. Constitution 16th Amendment Limitations: Purpose is for “the common defense and general welfare” Federal taxes must be the same in every state Government may not tax exports © 2010, TESCCC
Purposes of Taxation Raise revenueRegulate the economy (fiscal policy) Redistribution of income (transfer payments) Provide positive economic incentives Provide negative economic incentives © 2010, TESCCC
Types of Taxes or Tax StructuresProgressive - takes larger percent of income from higher income groups - as income goes up tax rate increases example- Federal Income Tax © 2010, TESCCC
Types - Regressive Regressive - takes larger percent of income from the lower income group Example - sales tax, property tax, Social Security tax © 2010, TESCCC
Types - Proportional Proportional - takes the same percent of income from all income levels Examples - some state income taxes & proposed flat tax © 2010, TESCCC
Principles of Taxation1. Benefits received - people who directly benefit or use the good or service should pay Example - Excise tax on gasoline used to build roads © 2010, TESCCC
Example - Federal Income Tax2. Ability-to-pay - people who have more wealth or income should pay more Example - Federal Income Tax © 2010, TESCCC
Top Federal Taxes Individual Income Tax Social SecurityCorporate Income Tax © 2010, TESCCC
Federal Taxes © 2010, TESCCC
FICA FICA=Social Security + MedicareFICA Taxable Wage Base or a cap - a maximum income level that can be taxed. All income above that level is not taxed for FICA, tax free. Employers match employee contributions. © 2010, TESCCC
State Taxes States receive most of their revenue from a sales tax.© 2010, TESCCC
Local Taxes Property Tax © 2010, TESCCC
Who Bears the Burden of a Tax?To fully evaluate the fairness of a tax, it is important to think about who bears the final burden of the tax or the incidence of a tax. © 2010, TESCCC
Government Spending Goods and Services Transfer Payments© 2010, TESCCC
Until Great Depression, government did little to influence economy persistent unemployment, low production changed many economists minds John Maynard.
Spending, taxing, & borrowing policies Government collects taxes to pay programs (Roads, education, National Defense) Taxes used to influence behavior.
1 Chapter 21 Fiscal Policy Key Concepts Key Concepts Summary Practice Quiz Internet Exercises Internet Exercises ©2002 South-Western College Publishing.
GDP THE MARKET VALUE OF ALL FINAL GOODS AND SERVICES PRODUCED WITHIN A NATION IN A GIVEN TIME.
Today’s Warm Up Turn to page 396 and read the section, “A New Role for Government” In your notes, define Keynesian Economics and be ready to share!
Fiscal Policy. *The government has three roles in the economy: TAXATION, SPENDING, & REGULATION.
Taxes, Fiscal, and Monetary Policies
Fiscal Policy Chapter 15. Setting Fiscal Policy: The Federal Budget $7.7 Billion a day spent by government Fiscal Policy is the use of government.
Fiscal Policy Government Spending AndTaxes. Fiscal Policy Government spending Government spending – Increase: stimulates the economy – Decrease: slow.
Fiscal Policy. Section 1 Fiscal Policy is the federal government’s use of taxing and spending to keep the economy stable -Government spending has a.
15-1 Understanding Fiscal Policy
Chapter 15: Fiscal Policy Section 2
Using Fiscal Policy. Fiscal Policy is the federal government’s use of taxes and government spending to affect the economy. There are three primary.
15-1 Understanding Fiscal Policy What is fiscal policy and how does it affect the economy? How is the federal budget related to fiscal policy? How do expansionary.
Presentation Pro © 2001 by Prentice Hall, Inc. Economics: Principles in Action C H A P T E R 15 Fiscal Policy.
Fiscal Policy Taxing, Spending, & Borrowing Policies of the Federal Government— done by Congress.
Fiscal Policy History. Growth of the Federal Government 1930s The New Deal young men worked on infrastructure 1940s WWII everyone worked on war production.
1 Fiscal Policy SECTION 1: Defining Fiscal Policy SECTION 2: Fiscal Policy Strategies SECTION 3: Fiscal Policy and the Federal Budget CHAPTER 15.
Chapter 15SectionMain Menu Understanding Fiscal Policy What is fiscal policy and how does it affect the economy? How is the federal budget related to fiscal.
Chapters 15 & 16. T WO TOOLS: F iscal & Monetary Policy W hat’s the difference? F iscal Policy T he Budget – taxing and spending T he use of government.
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