Econ Chapter 17 Government Budgets and Fiscal Policy

Discretionary spending

the portion of the federal budget that must be approved annually by Congress and the President through the appropriations process. It includes funding for programs like national defense, education, transportation, and science 

Mandatory spending

determined by existing laws for programs like Social Security and Medicare. 

Supplemental spending

 appropriations enacted after the regular annual appropriations when the need for funds is too urgent to wait for the next regular appropriations.

Proportional tax rate

is the same as a flat tax rate.  

• Sales tax

Regressive tax rate

• a tax system where the tax burden falls more heavily on low-income individuals than on high-income individuals 

• Social Security is taxed at a regressive rate (earners under $176,100 pay a 6.2% rate, if you earn more than that you pay less) 

Progressive tax rate

a tax system in which the tax rate increases as the taxable amount or income increases  

Automatic stabilizers

 Government spending and taxes that automatically increase or decrease along with the business cycle are called automatic stabilizers.

Budget deficit

 If the federal government’s expenditures are greater than its tax revenue, they are operating under a budget deficit.

Budget surplus

If the federal government’s expenditures are less than its tax revenue, they are operating under a budget surplus.

Autonomous expenditure

spending that occurs regardless of income levels, such as for basic necessities or government spending. It is considered independent of changes in income, unlike induced expenditure, which varies with income.  

• For example, individuals must pay for rent or food even if their income is zero, and the government must fund defense spending regardless of the current GDP.

Marginal propensity to consume

 MPC refers to the fraction of an additional dollar of income that is spent on consumption rather than saved. 

• 𝑀𝑃𝐶 = 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 / 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐼𝑛𝑐𝑜𝑚𝑒  

• So, for example, if I receive a $500 bonus and spend $400 of it, my MPC is 0.8.  A higher MPC means households will spend more of any extra income, which can stimulate economic growth.  

• A lower MPC indicates that more of any extra income is saved.  

• The MPC is crucial for calculating how changes in government spending or taxes will affect overall consumer spending and the economy.  

  • MPC low gov injects money into the economy

• Individuals can choose to consume or save with their income, which means 

MPC + MPS = 1  MPS is your marginal propensity to save

Multiplier effect

process by which an initial change in spending (like investment or government expenditure) leads to a larger overall change in national income/output.

• Essentially, one person’s spending becomes another person’s income, which they then spend, creating a chain reaction.

• 𝐺𝑜𝑣𝑒𝑟𝑛𝑚𝑒𝑛𝑡 𝑆𝑝𝑒𝑛𝑑𝑖𝑛𝑔 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 = 1/ (1 − 𝑀𝑃𝐶)

How does the process of approving mandatory spending differ from discretionary Spending?

Mandatory Spending

Examples: Social Security, Medicare, Medicaid, unemployment benefits, SNAP

• Mandatory spending is written into permanent law.

• Congress does NOT approve it each year during the budget process.

• Instead, Congress must pass a new law to change:

  • eligibility rules

  • benefit formulas

  • payment amounts

Discretionary Spending

Examples: Defense, education, transportation, NASA, FBI, national parks

• Discretionary spending is determined every year by Congress through the annual appropriations process:

  1. President submits a budget request

  2. The House and Senate create budget resolutions

  3. 12 appropriations bills are drafted and passed

  4. The President signs them into law

What are the different types of tax rates, and what are examples of each? 

Proportional

Rate stays the same

Flat income tax rate, Medicare tax

Regressive

Rate gets lower

Sales tax, Social Security tax cap, excise taxes

Progressive

Rate gets higher

Federal income tax, estate tax

When would expansionary fiscal policy be implemented, when would contractionary fiscal policy be implemented, and how does it influence the aggregate market and the Phillips curve?

Expansionary Fiscal

Recession, high unemployment

↑ G, ↓ taxes, ↑ transfers

AD → right

Down along SRPC (↓ unemployment, ↑ inflation)

Contractionary Fiscal

High inflation, overheating

↓ G, ↑ taxes, ↓ transfers

AD → left

Up along SRPC (↑ unemployment, ↓ inflation)

What does the marginal propensity to consume measure, and how does it change depending on where we are in the business cycle?

• MPC refers to the fraction of an additional dollar of income that is spent on consumption rather than saved. 

• A lower MPC indicates that more of any extra income is saved.  

• The MPC is crucial for calculating how changes in government spending or taxes will affect overall consumer spending and the economy.  

  • MPC low gov injects money into the economy

What is the government spending multiplier, and how do we use it to estimate how much to increase or decrease government spending?

•  The government purchases multiplier measures the total impact on GDP from a change in government spending. 𝐺𝑜𝑣𝑒𝑟𝑛𝑚𝑒𝑛𝑡 𝑆𝑝𝑒𝑛𝑑𝑖𝑛𝑔 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 = 1/ 1 − 𝑀𝑃𝐶  If the MPC is 0.6 and the government increases spending by $50 million, the increase in real GDP would be $125 million.

What is the tax multiplier, and how do we use it to estimate how to increase or decrease taxes?

• The Tax Multiplier measures the total impact on GDP from a change in taxes. 𝑇𝑎𝑥 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 = −𝑀𝑃𝐶 /(1 − 𝑀𝑃𝐶)  The tax multiplier is negative because it measures the inverse relationship between changes in taxes and GDP. A tax increase leads to a decrease in GDP, and a tax cut leads to an increase in GDP.  For example: If the MPC is 0.75 and you received a $100 tax cut, then the increase in real GDP $300.