Fiscal Policy: Fixing an Economy’s Health

What is Fiscal Policy? The use of Government policies in order to stabilize the Business Cycle.

Points to Remember  Prior to the Great Depression (1930’s) economists believed that the best way to stabilize the economy was through the natural market forces/ Adam Smith  After the Depression: The gov’t stepped in (FDR) to help. This action (Fiscal Policy) is an example of (John) Keynesian Economics.

Policy Theory in Our Govt.  Republican/ Conservative General Theory: –Small government –Generally Low taxes –Individual responsibility –Less govt. control & regulations  Democrat/ Liberal General Ideas: –Progressive taxes/ make more you pay more –Social programs/ community responsibility –Govt. regulation –Larger govt. to support people

Important Concepts:  GDP: Gross domestic product is the aggregate (total) market value of all final goods and services produced within a country in a given period of time. –Sometimes the measurement is looked at on a per person scale, which is known as…REAL GDP.  Inflation: is a sustained increase in the average price level of goods and services.  Stagflation: A period of inflation combined with high unemployment (a recession or depression)

The 3 “tools” of Fiscal Policy: 1.Government Purchases & Spending 2. Entitlement Programs (also called Transfer Payments) 3. Taxes …these three tools impact macroeconomic variables such as real GDP, employment, price level, and economic growth. G.E.T.

Multiplier Effect  For every dollar spent by the federal government, GDP will increase by more than that $1  It takes money to make money!

$200 Multiplier Effect: each dollar spent will tend to generate more than 1 dollar added to GDP. How just a little Fiscal Policy can effect our economy in a BIG way. $150 $150 $50 (already in his pocket) $200 already in his pocket) $400

Fiscal Policy and Taxes  An increase in tax rates = decreased disposable income = consumption & real GDP decrease  A decrease in taxes = increases disposable income = consumption & real GDP increase  What is disposable income??

Fiscal Policy and Taxes Taxes Disposable Income Consumption & Real GDP Taxes Disposable Income Consumption & Real GDP So which is better HIGHER or LOWER TAXES? WHY?

When to use Fiscal Policy? 1. When the economy is in a recession or depression the economy has contracted.  The government will enact an Expansionary Fiscal Policy to help boost the economy.

Expansionary Fiscal Policy  When to use: (recession) supply is bigger than demand because people are not spending.  What to do: –increase gov’t purchases –decrease taxes –increase entitlements (transfer payments) to stimulate economy.

Government Use of Fiscal Policy 2. When the economy is in an economic boom/ peak the economy has expanded.  The government will enact an Contractionary fiscal policy to help slow down the economy.

Contractionary Fiscal Policy  When to use: (peak) demand exceeds supply because people have too much money.  What to do: –decrease gov’t purchases –increase taxes –decrease Entitlements (transfer payments) to close expansion gap.

Sum it up... Economy is in a recession or depression Expansionary Fiscal Policy Economy is in a boom/peak Contractionary Fiscal Policy

Problems with Fiscal Policy  Doesn’t work during periods of stagflation- can’t fight unemployment and inflation at the same time  Entitlements or transfer payments: –It is difficult to estimate the natural rate of unemployment- people lie!  The time lags involved in implementing fiscal policy (takes the government a long time to do anything).  AND…..

More Problems with Fiscal Policy  Economists and policy makers question the effectiveness of fiscal policy because of deficits. The government experiences a budget deficit during expansionary fiscal policy. The government experiences a budget deficit during expansionary fiscal policy. GOV. SPENDING + BUDGET DEFICIT (negative) = TAXES (Revenue for Gov.)

Fiscal Policy’s Effects on Labor

 If the government does anything to pump money into the economy, then the labor supply should increase along with the number of jobs available.  However, the unemployed, who benefit from increased transfer payments (Expansionary Fiscal Policy), may have less incentive to find work.

Fiscal Policy’s Effects on Labor  Inversely, during Contractionary Fiscal Policy, workers who find their wage reduced by the higher tax rates may be less willing to work.  The supply of labor could decrease as a result of increased tax rates or increased transfer payments resulting in aggregate supply declining.  Which will cause an economy’s GDP to decline.  Simply, there is not enough workers so wages increase.

Taxes: Who Should Pay Less or More?

1.) Progressive Income Tax Table Single filersMarried filing jointlyHead of household Tax Rate Up to $7,150 Up to $14,300 Up to $10,200 10% $7,151 - $29,050 $14,301 - $58,100 $10,201 - $38,900 15% $29,051 - $70,350 $58,101 - $117,250 $38,901 - $100,500 25% $70,351 - $146,750$117,251 - $178,650$100,501 - $162,700 28% $146,751 - $319,100 $178,651 - $319,100 $162,701 - $319,100 33% $319,101 or more $319,101 or more $319,101 or more 35%

TWO THEORIES ON WHO SHOULD PAY TAXES 1. Benefits-Received Principle Only those who receive benefits should pay taxes. EXAMPLE: City of Canton is building a new parkway to limit the amount of traffic so a tax is raised to pay for it. ONLY those who use the parkway should pay (the citizen of Canton, NOT the citizens of Hickory Flat) EXAMPLE: Gasoline Sales Tax goes toward road construction (you ride on them, you pay for them) 2. Ability-to-Pay Principle Only those with the ability to pay should pay MORE of the tax. EXAMPLE: Same Canton situation, but those who pay more of the tax should be the wealthy.

TYPES OF TAXES 1. Progressive Tax (ex-income tax) Those who make more, pay more 2. Regressive Tax  A regressive tax is a tax which takes a LARGER PERCENTAGE of income from people whose income is LOW.  Regressive taxes, as opposed to progressive taxes, are more burdensome on lower-income individuals than on higher-income individuals. (EXAMPLE: SALES TAX) 3. Proportional Tax (EX: FAIR TAX) A tax that charges the same percentage of income, regardless of the size of income.

2) Progressive Income Tax INCOME = GDP & AD/ consumption = INCOME TAXES DURING A PEAK: INCOME== INCOME TAXES DURING A RECESSION: How it works. GDP & AD/ consumption

TYPES OF TAXES 2. Regressive Tax  A regressive tax is a tax which takes a LARGER PERCENTAGE of income from people whose income is LOW. Social Security tax is an example. For 2012, you pay 6.2% tax on wages up to a maximum wage of $97,500. Therefore:  A person who makes $30,000 a year pays $1,860 (30,000*.062) in tax or 6.2% of wages.  A person who makes $200,000 a year pays $6,045 (97,500*.062) in tax or 3% of wages.  A person who makes $500,000 a year still pays $6,045 in tax (97,500*.062) or 1.2% of wages.

TAX APPLICATIONS: 1. Personal Income Tax Progressive 2. Sales Tax Regressive & Proportional 3. Corporate Income Tax (28% for all corporations) Regressive 4. Property Taxes: Pay for CC schools & (based on value of property) Is this fair for everyone? Regressive Identify whether progressive, regressive, or proportional & Proportional

ANY QUESTIONS?