chapter 23 - government spending, taxes, fiscal policy

macro

automatic stabilizers

social insurance

government provided insurance against bad outcomes such as unemployment, illness, disability, or outliving your savings (some of the biggest slice of federal spending

mandatory spending

spending on programs that does not get determined annually; instead it is set in law

discretionary spending

spending that congress appropriates annually (funding for federal agencies and most government program ) government can only spend money that congress has appropriated - in contrast to mandatory spending

income tax

you pay income taxes on ALL incomes, regardless of its source (includes income you earn from working + unearned income such as investment, income, capital gains, inheritance/gift - money you receive in a year from all sources

DO NOT CONFUSE THIS WITH WEALTH, WHICH IS YOUR STOCK OF SAVINGS AND ASSETS

payroll tax

apply only to earned income

used to fund social insurance programs like social security and medicare

earned income

- includes wages from an employer, or net earnings from self-employment (also includes bonuses, commissions, and other payments from your employer)

progressive tax

those with more income tend to pay a higher share of their income in tax

taxable income

the amount of your income that you pay taxes on

marginal tax rate

the tax rate you pay if you earn another dollar

note: taxable income is not the same thing as the total income you receive

excise tax

tax on specific product, such as gas, cigaretts, or alochol.

Unlike a regular sales tax, excise taxes are usually levied based on the quantity you buy, not the price you pay

property taxes

a tax on the value of property, usually real estate

regressive tax

a tax where those with less income tend to pay a higher share of their income on the tax

lower income households spend a higher share of their income on things like gas, housing, groceries, clothing- meaning that they also spend a higher share of their income on taxes on these items

tax expenditure

describe the special deductions, exemptions, or credits that lower your tax obligation , to encourage you to engage in certain kinds of activities

refundable tax credit

a tax credit for which receiving the credit doesn’t depend on owning income taxes

3 reasons why tax expenditures primarily benefit the wealthy

1. value of tax exclusion and deductions is higher when your income tax rate is higher

2. higher income people tend to buy more tax- preferred goods + services

3. most tax expenditures don’t provide much help if your income tax bill is 0

reason 1: value of tax exclusions an deductions is higher when your income tax rate is higher

ex: highest income- 37% marginal income tax rate (every $100 spent paying mortage interest reduces person’s bill by $37)

middle income- 12% marginal income tax rate > every $100 spent paying mortgage interest reduces person’s tax bill by $12

lowest income- doesn’t pay federal income taxes (no benefit received from this tax deduction)

reason 2 : higher income people tend to buy more tax preferred goods and services

high income- buys a million dollar house

middle income- buys a $400,000 dollar house

reason 3: most tax expenditures don’t provide much help if your federal income tax bill is zero

most tax breaks reduce your taxable income

>but if your income tax bill is already zero, then you can’t go any lower !

federal spending

social insurance programs, military

state spending

social insurance programs, education

local spending

education, community services

the 3 Ts of fiscal policy

-timely : policymakers must act quickly

-targeted : fiscal policy should focus on the specific regions, industries, and groups of workers who need the most help

-temporary : extra spending is no longer required when the economy has recovered

fiscal policy

refers to the government’s use of spending and tax policies to attempt to stabilize the economy

expansionary fiscal policy

higher government spending and/or lower taxes to increase aggregate expenditure in response to output below potential

(typically, the government responds to weak output with an expansionary fiscal policy)

contractionary fiscal policy

lower spending and higher taxes will reduce output

lower government purchases and/or higher taxes to decrease aggregate expenditure in response to output above potential

(if the economy is over heating, then the government decreases spending and raises taxes in order to weaken aggregate demand for output and, thus lower GDP)

government spending can add to GDP directly and indirectly. 2 types of government spending

1. government purchases

2. transfer payments

government purchases

government directly purchases goods and services such as schools, military equipment, vaccine development, and high ways

transfer payments

money that’s taken from the government’s coffers and sent to individual households

(distinction matters)

government purchases are counted directly in GDP BUT transfer payments don’t directly add to GDP because nothing is purchased or produced.

However, when people who receive transfer payments spend that money, they boost aggregate expenditure

(the multiplied effect makes fiscal policy most potent)

discretionary fiscal policy

policy that temporarily changes government spending or taxes to boost or slow the economy

(if the economy starts slipping into a recession, congress may consider passing legislation to temp. increase sending or cut taxes, towards boosting the economy)

crowding out

sometimes, a rise in expansionary fiscal policy will lead to a decline in private spending, and particularly investment

automatic stabilizer

spending and tax programs that adjusts as the economy expands and contracts, without policymakers taking any deliberate action

>automatic - no action required by policymakers

>stabilizind - these adjustments are counter cyclical (boosts output during recessions, reduces output during expansions)

progressive tax system

helps encounter both booms and busts

>bust: drop into a lower tax bracket which allows consumer to keep (and spend) more

>boom : rise into a higher tax bracket which means consumers keep (and spend) less that they otherwise would

budget deficit

the difference between spending and revenue in a year in which spending exceeds revenue (a budget deficit for a given year adds to the total debt

budget surplus

the difference between spending and revenue in a year in which revenue exceeds spending (budget surplus for a given year can be used to repay debt

gross government debt

the total debts of the federal government

net government debt

the debt that the government owes to individuals, businesses, and other gov programs both here and abroad

unfunded liability

a commitment to incur expenses in the future without a plan to pay for those expenses

4 facts about government spending and revenue

1. federal gov typically runs budget deficits

2. persistent large budget deficits are a relatively recent phenomenon

3. wars and pandemics require a sudden surge of spending that results in budget deficits

4. business cycles create budget deficit cycles

when should the government run deficits ?

typical perspective

alternative perspective

typical perspective

budget deficit reflect a mismatch between how much the government spends and how much revenue it takes in

alternative perspective

budget deficits reflect a mismatch between when the government spends and when it takes in the revenue to pay for this spending

-this perspective suggests deficits often make sense !

unfunded liability

a commitment to incur expenses in the future without a plan to pay for them

reasons to worry about government debt

1. slower economic growth

2. future fiscal choices are constrained

3. the risk of a crisis of confidence (A perceived risk of not getting paid would lead lenders to charge the government a higher interest
   rate, making it difficult/impossible to make loan repayments)

4. a debt crisis becomes more likely

reasons to not worry about government debt

1.Most of our government debt is money owed by Americans to Americans.
2. Future generations can help repay the debt.
3. It wouldn’t take a big adjustment to repay the debt.
4. The government never really needs to repay the debt.
5. The government has options that you don’t.
-Raise taxes
-Print money (but beware of inflation, or worse, hyperinflation)

affordable care act

is an example of discretionary spending

suppose a high-income person, a middle income person, and a low income person all purchase identical houses that are financed by similar mortgages. who spends the most on tax preferred goods ?

-middle income person

-high income person

-they all spend the same on tax preferred goods

-low income person

high income person

suppose a high-income person, a middle income person, and a low income person all purchase identical houses that are financed by similar mortgages. who gets the largest tax benefit ?

-middle income person

-high income person

-they all pay the same tax rate

-low income person

high income person