McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Fiscal Policy, Deficits, and Debt Chapter 13 McGraw-Hill/IrwinCopyright © 2015 by McGraw-Hill Education. All rights reserved.

Discretionary Fiscal Policy I. Two Types of Fiscal Policies 1.Fiscal policies = the government using government spending (G) and taxes (T) to affect Y. 2.Type 1: Discretionary fiscal policies (i)During economic recession - The government chooses to increase G and/or decrease T to minimize recession (from Chapter 12). These are expansionary fiscal policies. (ii)During economic boom - The government chooses to decrease G and/or increase T to minimize inflation (from Chapter 12). These are contractionary fiscal policies.

Automatic Fiscal Policy LO1 3.Type 2: Automatic, or built-in, fiscal policies - If taxes are set as a percentage of income, such as T = 0.2Y, then … (i)Tax revenue will automatically fall during economic recession. - Example: - Case 1: Y = 1,000, T = 200 versus T = 0.2Y, tax revenue = ___________. - Case 2: Y = 800, T = 200 versus T = 0.2Y, tax revenue = _____________. - The recession will be less severe in case _______ because consumption will fall by less, given that C = (Y-T). (ii)Exercise: Show that tax revenue will automatically rise during economic boom. (iii)When taxes are set as a percentage of Y, taxes act as an automatic stabilizer for the economy. Need for government intervention is less.

Automatic Fiscal Policy 4.Most countries have a progressive percentage tax system. - Progressive tax system = the higher the income, the higher is the tax rate. (i)Thailand - Income above 150,000 baht per year is taxed from 10% to 37%. Source: (ii)Canada - Income above C$11,138 per year is taxed from 31% to 58.75%. Source:

Actual Fiscal Budgets LO3 II. Actual Fiscal Budget Balance 1.Actual fiscal budget balance = BB = tY-G. - For a given year, we can find data on the tax revenue of the government (tY) and compare it with the expenditure of the government (G). (i)If BB = tY – G > 0, then the government ran a budget surplus. (ii)If BB = tY – G < 0, then the government ran a budget deficit. 2.If BB < 0, is it necessarily due to increasing G and/or decreasing T, that is, the government’s “fault”? 3.Or is the BB < 0 due to a falling Y?

Actual Fiscal Budgets LO3 4.Graphically, suppose t=0.2 and G=200, so BB = 0.2Y We can see that even when G and t are held constant, i.e., the government is not doing anything differently, BB can become > 0, < 0 or = 0 if Y changes. - Therefore, if Thailand goes into a budget deficit, it could be due to changes in G, t or Y, or all. By just looking at the value of BB does not tell us much. - Is BB<0 during a recession necessarily a concern?

Cyclical Fiscal Budgets LO3 III. Cyclically-adjusted Fiscal Budget Balance 1. We want a measurement that keeps Y relatively constant, so that changes in the budget are due to t and/or G changes. 2.This allows us to examine how the government has changed t and/or G. The result is the cyclically-adjusted BB. 3.The news media sometimes refers to the cyclically-adjusted BB as the structural BB (SBB).

Cyclical Fiscal Budgets 4.Structural budget balance = SBB = tYp-G. - We replace actual Y with potential Yp, which does not fluctuate as much as actual Y. Therefore, changes in SBB are due to G and t changes, not Y changes. 5.Given that SBB is evaluated at the potential Yp, and the potential Yp is much more stable than actual Y, changes in SBB are mainly due to changes in t and/or G. (i)If SBB = tYp – G > 0, then the surplus is mainly due to (contractionary, expansionary) fiscal policies. (ii)If SBB = tYp – G < 0, then the deficit is mainly due to (contractionary, expansionary) fiscal policies.

Deficits and Debts IV.Public Debt 1.Public debt is the accumulation of past annual deficits and surpluses. 2.Public debt changes with current deficits or surpluses. Specifically,  Public Debt = -BB - if BB > 0, public debt (drops, rises). - if BB < 0, public debt (drops, rises). LO4

Thailand’s Data LO3 V. Thailand’s Data and Observations Source: