Fiscal Policy Government action to influence the economy Reference 15.1

Fiscal Policy Expansionary: Increase total spending to reduce unemployment Contractionary: Reduce total spending to reduce inflation

Expansionary Fiscal Policy The government can decide to: 1.Increase government spending 2.Lower taxes 3.Do both Will this policy achieve its goal???? Will this policy achieve its goal????

maybe… Will additional government spending “crowd out” private spending? Example: An additional $2,000,000 dollars spent on education by government may result in consumers spending $2,000,000 less on private school tuition. A Comparison: “Harry Potter”

The General Theory of Employment, Interest, and Money John Maynard Keynes The General Theory of Employment, Interest, and Money Revolutionizes thinking about the government’s role in the economy. – Influential to the “New Deal” Argued for expansionary fiscal policy in times of recession or depression

Contractionary Fiscal Policy The government can decide to: 1.Reduce government spending 2.Increase taxes 3.Do both NOT VERY POPULAR…But will it work?

maybe… Will private spending “crowd in”? Will consumers spend more when faced with less government spending? Example: The schools are so under-funded that parents spend money to put their kids in private schools.

How Taxes Can Affect Spending After-tax income: what you have left to spend after you’ve paid income taxes. Higher after-tax income increases demand (expansionary) low tax rate Lower after-tax income decreases demand (contractionary) high tax rate

How Taxes Can Affect Supply If you were taxed at 100%, would you work? High tax rates can reduce productivity

Tax Rates ….Tax Revenues Will higher tax rates give the government greater tax revenues? Will lower tax rates give the government smaller tax revenues? Only if INCOME is constant.

Laffer Curve controversial theory created by economist Arthur Laffer represents the relationship between tax rates and tax revenues. What is the ideal tax rate?What is the ideal tax rate?

Review What is expansionary fiscal policy, and for what purpose is it likely to be implemented? What is contractionary fiscal policy, and for what purpose is it likely to be implemented?

Review Is expansionary fiscal policy always effective at increasing total spending and decreasing unemployment? Explain your answer?

Review Someone says, “If the federal government cut income tax rates, tax revenues will rise.” Might this person be wrong? Explain your answer.

Homework Read and note Ch “Taxes” pages Complete Section Review p. 430 #2-4

Current Issue: How will the repeal of the Bush tax cuts affect the economy?