Chapter 11 Fiscal policy Economics, 8th Edition Boyes/Melvin
Copyright © Cengage Learning. All rights reserved. Fiscal Policy Fiscal policy (government spending and taxation) is one tool that government uses to guide the economy along an expansionary path. By varying the level of government spending, policymakers can affect the level of real GDP. Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved. Multiplier effects If the price level rises as real GDP increases, the multiplier effects of any given change in AE are smaller than they would be if the price level remained constant. Government spending must be financed by some combination of taxing, borrowing, and creating money. Government spending = taxes + change in government debt + change in government-issued money. Copyright © Cengage Learning. All rights reserved.
Government Spending Financed by Tax Increases Government increases spending, but finances it with tax increases. The increase in spending shifts AD to the right, but the increase in taxes reduces the incentive to work, shifting AS to the left. Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved. Crowding Out An increase in government spending financed by borrowing can reduce consumption and investment. As interest rates are driven higher by government borrowing, private investment is “crowded out” by debt-financed government spending. Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved.
Expansionary Fiscal Policy: “Crowding-out” of Investment When Government spending increases or Taxes decrease, the government must borrow in order to continue spending. This leads to an increase in the demand for loanable funds or a decrease in the supply of loanable funds, which results in a r% increase. This change in r% leads to Investment Spending decreasing. Because Investment Spending is a direct component of AD, these decreases offset some of the increase in AD. Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved.
Contractionary Fiscal Policy: “Crowding-in” of Investment When Government spending decreases or Taxes increase, then the government develops a budget surplus. This leads to an decrease in the demand for loanable funds or a increase in the supply of loanable funds, which results in a r% decrease. This change in r% leads to Investment Spending increasing. Because Investment Spending is a direct component of AD, these increases offset some of the decrease in AD. Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved. Fiscal Policy Discretionary Fiscal Policy: changes in government spending and/or taxation aimed at achieving a policy goal. Automatic Stabilizer: an element of fiscal policy that changes automatically as income changes. Copyright © Cengage Learning. All rights reserved.
Implications of Deficits and National Debt Crowding out means a smaller future capital stock and lower output in the future. Higher interest rates cause currency appreciation, leading to import increases and net export decreases, reducing GDP. This is international crowding out. Higher national debt means higher interest payments paid by the government. Copyright © Cengage Learning. All rights reserved.
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Automatic Stabilizers Progressive Taxes: a tax whose rate rises as income rises. U.S. income taxes currently range from a rate of 10% to 39.6% depending upon annual income. Transfer Payments: a payment to one person that is funded by taxing others Employees and employers in the U.S. pay a 7.65% Fica tax (Social Security and Medicare) to fund a variety of benefits administered through the Social Security program Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved. The curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point (E) would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100% (the top of the curve), then all people would choose not to work because everything they earned would go to the government Copyright © Cengage Learning. All rights reserved.
Copyright © Cengage Learning. All rights reserved. Taxation Two types of taxes: direct taxes: on individuals and firms. For example, income taxes and value-added taxes (VAT). indirect taxes: on goods and services Three types of tax rate structures: progressive tax: rate increases with higher income. regressive tax: rate falls with higher income. proportional tax: rate is constant. Copyright © Cengage Learning. All rights reserved.
Individual Income Tax 2015 Tax Bracket Single 10% Bracket $0 - $9,225 $9,226-37,450 25% Bracket $37,451-90,750 28% Bracket $90,751-189,300 33% Bracket $189,301-411,500 35% Bracket $411,501-413,200 39.6% Over $413,200