2. Types of budgets: 1. Balanced: Expenditures = Revenues 2. Surplus: Expenditures < Revenues 3. Deficit: Expenditures > Revenues Spending Plan – formal or informal

3. How the Federal Government Spends A breakdown of the government expenditures at the federal level. 19% 6% Transportation Other 22% Income Security Medicare and health Defense Net Interest Social Security 3.1% 10.4% 24% 15.5%

4. Federal Government Spending (Source: Economic Report of the President, Tables B-2 and B-22, http://www.gpo.gov/fdsys/pkg/ERP-2014/content-detail.html)

5. How State & Local Governments Spend Insurance trusts Public welfare & Health Police & Fire Protection Transportation Utilities & liquor stores Education Administration & other Interest on debt 22.3% Public welfare & Health 7.7% 32.2% 12.2% 4.3% 7.1% 6.3% 7.9%

6. State and Local Government Spending Spending by state and local government increased from about 10% of GDP in the early 1960s to 14–16% by the mid-1970s. The single biggest spending item is education. Source: (Source: Bureau of Economic Analysis.)

7. 19971994 Federal taxes: State & local taxes: How Government Taxes: Taxes vary by state Corporate income 12% Excise taxes 4% Customs duties 1% Corporate income 2% Other 4% Other 3% Property 15% Payroll 12% Personal income 10% User charges a 24% Sales and excise 17% From federal government 16% Payroll 34% Personal income 46% FL. MI, NH, TN (?) – no Income Tax NH motto: Live free or die... but they have a tax on parachute jumps

8. Federal Tax Receipts Federal tax revenues have been about 17–20% of GDP during most periods in recent decades (Source: Economic Report of the President, 2015. Table B-21, https://www.whitehouse.gov/administration/eop/cea/economic-report-of- the-President/2015)

9. A. Types of Taxes or how the tax changes with income changes u Progressive tax is one in which the average tax rate rises with income. - tax brackets, Federal Income Tax u Proportional tax is one in which the average tax rate stays the same across income levels. - flat tax, Social Security, Medicare, sales tax? u Regressive tax is one in which the average tax rate falls with income. - sales tax – higher income spend lower proportion on taxable goods Taxes!!!!!

10. A sales tax of 7 % on medicine A state income tax with 3 tax brackets A property tax of $2.85 per $100 of assessed property value A tax of $8 on room occupancy in all city hotels A tax of 3 % on all wages earned in the city A sales tax of 5% on utilities A federal tax of $2 per pack of cigarettes.

11. Expenditures < Revenues Expenditures > Revenue Discretionary changes in taxes and/or spending affect the Budget

12. Debt/GDP Ratio Annual deficits do not always mean that the debt/GDP ratio is rising. During the 1960s and 1970s, the government often ran small deficits, so the debt/GDP ratio was declining over this time. In the 2008–2009 recession, the debt/GDP ratio rose sharply. (Source: Economic Report of the President, Table B-20, http://www.gpo.gov/fdsys/pkg/ERP- 2015/content-detail.html)

15. 2003 -377 2004 -413 2005 -318 2006 -248 2007 -161 2008 -459 2009 -1413 2010 (estimate) -1556 2011 (estimate) -1267 2012 (estimate) -829

16. 1. Generally small deficits except during recessions. 2. Budget deficits generally increased during recessions and shrank during expansions, (automatic stabilizers, not discretionary policy) 3. Reductions in income tax rates and sharp increases in defense expenditures led to large deficits during the 1980s. 4. The deficits replaced by surpluses in the 1990s. 5. Real economic growth was strong and the inflation rate low during 80s and 90s

17. 6. The combination of: -the 2001 recession -the economy’s sluggish recovery -the Bush Administration’s tax cut, and -increases in defense spending quickly moved the budget from surplus to deficit at the beginning of the new century.

19. Federal Expenditures and Revenues Note the growth of budget deficits during the 1980s and the movement to surpluses during the 1990s. Federal Government Expenditures and Revenues (as a share of GDP) 18% 20% 22% 24% 1960196519701975198019851990199520002005 Expenditures Revenues Deficits 2010 Surplus Since 2002, the deficits have been sizeable and they soared to peacetime highs during the recession of 2008-2009.

20. Growth of Real Federal Government and Defense Expenditures During the 1980s, rapid growth of defense spending pushed federal spending upward and contributed substantially to the large deficits of the decade. During the 1990s, defense cuts retarded the growth of federal spending and thereby helped shift the budget to surplus. Defense Total 8 % 6 % 4 % 2 % 0 % - 2 % - 4 % Percent rate of change 19801985199019952000

21. Fiscal Policy & Economic Performance: In the 1960s, most economists believed fiscal policy was highly potent and could be used to smooth out the business cycle. Confidence in the ability of policy makers to implement countercyclical fiscal policy has waned. Most now believe that fiscal policy exerts only a modest impact on aggregate demand, much like the crowding-out and new classical models imply. Since 1980, real growth has been strong during periods of both expanding (1980s and 2002-2006) and contracting (1990s) deficits.

23. AD 1 Equilibrium below full employment. Two options Price Level LRAS Y F Y1Y1 P2P2 AD 2 Goods & Services (real GDP) directs the Economy to full-employment SRAS 1 P1P1 1. Wait for SRAS 1 to shift out to SRAS 2 SRAS 2 P3P3 market self- adjustment may be a lengthy process. e1e1 E2E2 2. Shift AD 1 out to AD 2 E3E3

24. Expansionary Fiscal Policy This graph shows that since the economy was originally producing below potential GDP, any inflationary increase in the price level from P 0 to P 1 that results should be relatively small.

25. AD 1 Equilibrium above full employment at Y 1. Price Level LRAS Y F Y1Y1 P3P3 AD 2 Goods & Services (real GDP) restrains demand and helps control inflation. SRAS 2 P1P1 1. Will lead to the long-run equilibrium E 3 at a higher price level as SRAS shifts to SRAS 2. or SRAS 1 P2P2 E3E3 2. Reduce demand to AD 2 and lead to equilibrium E 2. e1e1 E2E2

26. Contractionary Fiscal Policy A contractionary fiscal policy can shift aggregate demand down from AD 0 to AD 1, leading to a new equilibrium output E 1, which occurs at potential GDP, where AD1 intersects the LRAS curve. There is a larger effect on the Price level with this case The economy starts above potential GDP. The extremely high level of aggregate demand will generate inflationary increases in the price level.

31. Increase in budget deficit Higher real interest rates Inflow of financial capital from abroad Decline in private investment Appreciation of the dollar Decline in net exports

33. AD 0 1. Equilibrium at E 0 Price Level LRAS Y0Y0 Y1Y1 AD 1 Goods & Services (real GDP) P0P0 SRAS 1 P1P1 E0E0 e1e1 2. AD decreases to AD 1 and output falls to Y 1

34. AD 0 3. While policy is being enacted, private investment has begun to recover. Price Level LRAS Y0Y0 Y1Y1 Goods & Services (real GDP) P0P0 SRAS 1 P1P1 AD 2 E0E0 e1e1 4. AD has begun shifting back to AD 0 on its own, the effects of fiscal policy over-shift AD to AD 2. AD 1

35. AD 0 The price level in the economy rises (from P 1 to P 2 ) as the economy is now overheating. Price Level LRAS Y 0 Y1Y1 P2P2 Goods & Services (real GDP) P0P0 SRAS 1 P1P1 AD 2 E0E0 e1e1 e2e2 Y2Y2 Unless the expansionary fiscal policy is reversed, wages and other resource prices will eventually increase, shifting SRAS back to SRAS 2 (driving the price level up to P 3 ). P3P3 SRAS 2 E3E3

36. AD 0 1. Demand shifts AD out to AD 2, and prices upward to P 2. Price Level LRAS Y0Y0 P2P2 Goods & Services (real GDP) P0P0 SRAS 1 E0E0 Y2Y2 2. Restrictive Fiscal Policy is considered AD 2 e2e2

37. AD 1 AD 0 2. The price level falls (from P 2 to P 1 ) as the economy is thrown into a recession. Price Level LRAS Y0Y0 Y1Y1 P2P2 Goods & Services (real GDP) P0P0 SRAS 1 P1P1 AD 2 E0E0 e1e1 e2e2 Y2Y2 3. With the timing lag, fiscal policy does not work instantaneously.

38. 4. Investment returns to its normal rate (shifting AD 2 back to AD 0 ). Price Level LRAS Y0Y0 Goods & Services (real GDP) P0P0 SRAS 1 AD 2 5. The effects of fiscal policy over-shift AD to AD 1. P2P2 e2e2 Y2Y2 AD 1 Suppose that shifts in AD are difficult to forecast. E0E0 AD 0

41. AD 1 Price Level Y1Y1 Goods & Services (real GDP) SRAS 1 P1P1 Government deficit would shift AD 1 to AD 2. Household saving keeps demand unchanged at AD 1. AD 2 G G G G H H

42. Quantity of loanable funds Q1Q1 S1S1 Q2Q2 Loanable Funds Market Real interest rate r 1 S2S2 D 2 1. Government borrows from the loanable funds market, increasing the demand (to D 2 ). 2. People save for expected higher future taxes (raising the supply of loanable funds to S 2.) 3. Loans increase, but interest rate doesn’t. D 1 no effect on the interest rate, real GDP, and unemployment. e1e1 e2e2

45. AD 1 Price Level LRAS 1 Y F2 Y F1 AD 2 Goods & Services (real GDP) With time, lower tax rates promote more rapid growth (shifting LRAS and SRAS out to LRAS 2 and SRAS 2 ). SRAS 1 P 0 SRAS 2 E1E1 LRAS 2 E2E2 1. Lower marginal tax rates shifts AD 1 out to AD 2, and SRAS & LRAS shift to the right. 2. If the tax cuts are financed by budget deficits, AD may expand by more than supply, bringing an increase in the price level.

46. Their share of taxes paid has increased as the top tax rates have declined. This indicates that the supply side effects are strong for these taxpayers. Share of personal income taxes paid by top ½ % of earners 1964-65 Top rate cut from 91% to 70% 1981 Top rate cut from 70% to 50% 1986 Top rate cut from 50% to 30% 1990-93 Top rate raised from 30% to 39.6% 30 % 28 % 26 % 24 % 22 % 20 % 18 % 1960 16 % 14 % 1995199019801975197019651985 2000 1997 Capital gains tax rate cut 2001-2004 Top rate cut from 39.6% to 35% 2005

47. “Soaking the Rich?” Since 1986 the top tax rate has been less than 40%. The top one-half percent of earners have paid more than 25% of the personal income tax every year since 1997. Well above the 14% to 19% from the 1960s and 1970s.

48. 1. If an economy operates in the short run at point a, restrictive fiscal policy will a.increase AD and move the economy toward point c. b.decrease AD and move the economy toward point b. c.increase SRAS and move the economy toward point b. d.decrease SRAS and move the economy toward point c. 2. When the economy is operating at point a, reliance on the self-correcting mechanism will a.result in higher resource prices and a shift to the left in the SRAS curve. b.result in lower resource prices and a shift to the right in the SRAS curve. c.lead to lower interest rates and a shift to the right in the AD curve. d.lead to higher interest rates and a shift to the left in the AD curve. e.do both a and d. 3.Which of the following will a Keynesian most likely favor if the economy is operating at point a? a.a tax cut b.an increase in government expenditures c.restrictive fiscal policy d.an increase in the budget deficit

49. 4. If the output of the economy is Y 1, which of the following would a Keynesian economist be most likely to favor? a.a reduction in government expenditures b.an increase in government expenditures c.an increase in taxes d.continuation of the current tax and expenditure policies 5. If the output of the economy is Y 1, which of the following would a new classical economist be most likely to favor? a.a reduction in government expenditures b.a reduction in taxes c.an increase in taxes d.continuation of the current tax and expenditure policies

50. 6.When government expenditures exceed revenue from all sources, a.a budget deficit is present. b.the supply of money will increase. c.the government’s outstanding debt will decline. d.all of the above are true. 7.According to the Keynesian view, which of the following would most likely decrease aggregate demand? a.a decrease in tax rates b.a decrease in government expenditures c.an increase in transfer payments d.an increase in the budget deficit