Untitled Flashcards Set

Outlays and Revenue

• Government outlays = Federal Government Spending + Transfer Payments

Transfer Payments

• Social Security

• Income Assistance

• Payments made to individuals when no good or service is received in return

Historical Outlay Shares

• Mandatory Spending Items/Entitlement programs: Law passed that the government has to spend this money (Social Security, Medicare, Income aid) -> 62%

• Discretionary Spending: What politicians can decide on spending more or less on something ->30%

• Interest Payment -> 8%

• Marginal Rates: Good indicator of overall tax rates since 1913

Spending and Current Fiscal Issues

• Increased government spending due to a number of events

• Example: Increased defence spending due to 9/11, increased spending on social secuirty and medicare, governemnt responses to Great Rcession beginning with fiscal policy in 2008

Social Security and Medicare

Medicare

• Mandated federal program that funds healthcare for people aged 65 or older

• Established in 1965, goal of providing medical insurance for all retired workers

• Medicare tax rate is 2.9%

Social Security

• Government-Administered retirement program

• Requires workers to contribute a portion of their earnings to the Social Security Trust Fund

• Guarantee that no American worker retires without at least some retirement income 

• Tax rate is now to 12.4%

How to fix Social Security?

• Higher PayRoll Taxes

• Increase minimum retirement age: People will spend more years contributing to the trustfund

• Adjust the benefits computation using the consumer price index. Benefit payments to retirees are adjusted for inflation on the basis of average wage levels when they retire. This policy is in place to ensure that workers’ benefits keep up with standard-of-living changes during their working years. Currently, these payments are adjusted on the basis of an average wage index, which has historically increased faster than the CPI. If, instead, the CPI were used to adjust benefits payments, the payments would grow more slowly and yet still adjust for inflation.

• Means Testing: Wealthy individuals may not need SS, create threshold that individuals above an income would not receive SS + Cap at which you pay 6.2 tax

• Invest Soc. Sec Trust Fund inn higher return assets

How do Federal Governments raise revenue?

• Payroll Taxes (Deducted from Paychecks)

 - >Income tax, SS tax, and medicare tax combines for 81% of all federal tax revenue in 2010

      -    Other tax revenue sources

            ->Corporate Taxes, estate and gift taxes, excise taxes, and custom taxes

Taxes on Worker’s wages

• Social Insurance Tax

• Income Tax, 

• Progressive tax income: People with higher incomes pay more taxes

• Marginal Tax Rate: Tax rate paid on an individual’s next dollar of income 

• Average Tax rate: total tax paid divided by taxable income

Computing a tax bill based on a taxable income of  $60,000

• different tax rates apply: 10% on income up to $9,950; 12% on income from $9,951 to $40,525; and 22% on income from $40,525 to $60,000

• 0.10 x 9,950 = 995.00

• +0.12 x 40,525-9,950 = 3,669.00

• +0.22 x (60000 - 40525) = 4284.50

• Total: $8,948.50

Outlays and Revenues

• Occurs when outlays exceed revenues

• 2009: $1.4 trillion budget deficit, largest in US history

• Do not exceed WWII deficits when they are examined as portion of GDp

Deficit versus Debt

• Deficit does NOT equal debt

• National Debt: total of all accumulated and unpaid deficits

• Deficit: Shortfall in revenue for a particular year’s budget

• Debt: Total of

How does fiscal policy work

Fiscal Policy

• The use of government spending and taxes to influence the economy

• Taxes and spending changes must be legislated and approved by congress and president

• Can be used in conjunction with (or instead of) monetary policy to steer economy

Expansionary Fiscal Policy

• Government increases spending or decreases taxes to stimulate or expand economy

•  leads to increases in budget deficits and the national debt during economic downturns’

• however, expansionary fiscal policy might work for the overall economy, because spending by one person becomes income to another, which can snowball into income increases throughout the economy

Contractionary Fiscal Policy

• Government decreases spending or increases taxes to attempt to slow economy

• Shifts demand curve to the left to bring inflation down

-> Pay off government debt

-> Keep economy from expanding beyond long-run capabilities

- When policymakers believe that the economy is producing beyond its long-run capacity (Y1 > Y*), fiscal policy can be used to reduce aggregate demand.

-  . Contractionary fiscal policy moves the economy from short-run equilibrium at point a to equilibrium at point B, thus avoiding the inflationary outcome at point C.

Expansionary Fiscal

Increase government spending (G)

• Since G is one component of AD, increases in G directly increase AD

• If private spending (C, I, and NX) is low, then government can increase AD by increasing G

Decrease Taxes (T)

• Reducing the overall tax burden on private individuals gives them more to spend

• The focus is on increasing consumption spending

TCJA of 2017

• Reduction in personal income tax rates for most taxpayer + rate reduction for the tax on corporate profits

Foreign ownership of US federal debt

• foreign lending increases the supply of loanable funds in the United States, helping to reduce interest rate

• Lower interest rates mean that firms and governments in the United States can borrow at lower cost and thereby increase investment and hire more workers, and ultimately increase future production

• the increase in foreign ownership is a natural by-product of emerging foreign economies—as they get wealthier, they buy more U.S. Treasury bonds                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

Fiscal Policy, Recent examples

Economic Stimulus act, 2008

• Tax rebate for americans

• Typical four-person family received 1800, total of 168 billion

• Goal: hope that this money is spent, stimulating the economy

American Recovery and Reinvestment Act, 2009

• Focus on government spending

• 787 billion stimulus

• The goal of increasing AD     

Multipliers

Two multiplier concepts:

• Spending by one person becomes income to others; true for private and government spending

• Increases in income generally lead to increases in consumption

Marginal Propensity to consume (MPC)

• The portion of additional income that is spent on consumption

• MPC = Change in consumption/income 

Notes about MPC

• Not constant across all people

• 0<MPC<1

MPC multiplier illustration

• Suppose MPC = 0.75, what does this mean?

• Government increases G by 100 billion

• Workers get 100 income, spend 75

• Other people get 75 billion in income, spend 56.25 billion

Spending multiplier

• Spending multiplier

• Illustrates total impact on spending from an initial change of a given amount

• The larger the MPC, the higher the multiplier will be

• - Imagine that a small country is in recession and the government decides to increase spending. It commissions a very large Adam Smith statue for $50 million. To pay for the statue, the government borrows all of the $50 million. After the government borrows the $50 million, the interest rate rises from 3% to 4% and the equilibrium quantity of loanable funds increases from $500 million to $530 million.

• Savings adjustments

Supply Side Fiscal Policy

• Research & Develeopment Tax Credits:Gives firms an incentive to spend resources on technological advancement

• Policies that focus on education: Subsidies or taxbreaks for education (like pell grants) create incentives to invest in education, increasing effective labour resouces      

• Lower corporate tax rates: provides increased incentives for corporations to undertake activities that add more profit

• Lower marginal income tax rates: Create incentives for individuals to work harder and produce more, since they get to keep a larger share of their income

Laffer Curve

• If you were to decrease taxes in region 2, tax revenue would increase

• If you were to increase tax rated 

• income tax revenue = tax rate × income

GDP to Debt Ratio

Compute debt to GDP ratio

Step for 2001: 5807/10582 = 0.55

Step for 2020 : 26945/20894 =1.29

what are the major reasons why the national debt increased so much between 2001 and 2020?

• on the outlay side, U.S. government spending increased due to higher costs for Social Security and Medicare, and governmental responses to both the Great Recession and the COVID-19 recessio

Chapter 16: Fiscal Policy

Expansionary Fiscal Policy

• Occurs when the government increases spending or decreases taxes to stimulate the economy toward expansion

• A decrease in aggregate demand from AD1 to AD2 moves the economy from point A to equilibrium at point b, with less than full-employment output (Y1) and unemployment (u) greater than the natural rate (u*)

• In the long run, all prices adjust (short-run aggregate supply adjusts to SRAS2), moving the economy back to full-employment equilibrium at point C

• The goal of expansionary fiscal policy is to shift aggregate demand back to AD1 so that the economy returns to full employment without waiting for long-run adjustments.

Countercyle Fiscal Policy

• Fiscal policy that seeks to counteract business cycle fluctuations

• consists of using expansionary policy during economic downturns and contractionary policy during economic expansions

•  The goal of countercyclical fiscal policy is to reduce those income + employment fluctuations

Marginal Propensity to consume: MPC

MPC = Change in consumption/Change in income

• Example: you earn $400 in new income, and you decide to spend $300 and save $100. Your marginal propensity to consume is then $300 ÷ $400 = 0.75. In other words, you spend 75% of your new income

Spending Multiplier: (Ms)

• Tells us the total impact on spending from an initial change of a given amount

• Depends on the marginal propensity to consume: the greater the marginal propensity to consume, the greater the spending multiplier

If marginal propensity to consume is 0.75:

Why Fiscal Policy doesn’t work out perfectly

• Time lags: recognition lag, implementation lag, and impact lag.

• Automatic Stabilisers; government programs that automatically implement countercyclical fiscal policy in response to economic conditions + can eliminate recognition lags and implementation lags (Progressive income tax rate, welfare programs, unemployment compensation)

• Crowding out: When government spending substitutes for private spending, the overall change in aggregate demand diminishes, occurs when private spending falls in response to increases in government spending

New classical critique

•  fiscal policy asserts that increases in government spending and decreases in taxes are largely offset by increases in savings.