Fiscal Policy

Recall - Three Goals of EVERY Economy Stable Prices Low Unemployment Economic Growth

What is Fiscal Policy? Changes in the expenditures or tax revenues of the federal government, undertaken to promote full employment, price stability and reasonable rates of economic growth. Fiscal Policy contains two parts: Government Revenue Collection Government Spending

What is Govt Revenue Collection? Funds raised through taxing and borrowing to pay for government expenditures Remember, different levels of government collect different taxes and fees. Federal ? State ? Local ? Income Tax Sales Tax Property Tax

What is Government Spending? Used to provide a variety of services and programs for the public Can you provide examples for: Federal government ? State government ? Local government ?

Fiscal Policy The debate over how much to tax and how much to spend is often affected by what is happening in the economy Expansionary Policy Contractionary Policy Are we in a period of Economic Growth ? Are we in a period of Economic Decline ?

Types of Fiscal Policy IF Contractionary Policy DEFINITION: Economic Growth DEFINITION: A decrease in government spending and/or an increase in taxes designed to lower aggregate (overall) demand in the economy, thus cutting inflation (stabilizing prices)

FIGHT INFLATION (rising prices) Types of Fiscal Policy IF Contractionary Policy Economic Growth OPTIONS: 1) Reduce Government Spending So, why may you want a Contractionary Policy? Government buys fewer goods/services (less demand) Businesses may cut production, slowing growth rate Decreased demand will lower prices (FIGHT INFLATION) 2) Increase Taxes FIGHT INFLATION (rising prices) Individuals have less money to spend (less demand) Businesses may cut production, slowing growth rate Decreased demand will lower prices (FIGHT INFLATION)

Types of Fiscal Policy IF Expansionary Policy DEFINITION: Economic Decline DEFINITION: An increase in government spending and/or a decrease in taxes designed to increase aggregate (overall) demand in the economy, thus increasing real output and decreasing unemployment

Stimulate Growth & Employment Types of Fiscal Policy IF Expansionary Policy Economic Decline OPTIONS: 1) Increase Government Spending So, why may you want an Expansionary Policy? Government buys goods/services (increasing demand for goods) Govt spending on social programs gives people money to spend Businesses will increase production, raising employment 2) Decrease Taxes Stimulate Growth & Employment Individuals have more money to spend (increasing demand) With higher demand businesses produce, raising employment With lower taxes, businesses keep more profit, investing and growing

Approaches to Fiscal Policy Classical Economics Keynesian Economics Supply-Side Economics

Classical Economics Developed by Adam Smith (1776) DEFINITION: Theory Developed by Adam Smith advocating laissez-faire ideas, such as, minimum government intervention, free enterprise, and free trade

Classical Economics Developed by Adam Smith (1776) Belief that the economy is “self correcting” Gov’t should not attempt to “help” the economy Do not charge taxes (minimal) Do not incorporate much government spending “Laissez-Faire” - Hands off ! Before 1930s, US government followed a Classical economic policy What changed this?

Keynesian Economics Developed by John Maynard Keynes (1930s) “Demand Side Economics” Developed by John Maynard Keynes (1930s) DEFINITION: The macroeconomic theory holding that business cycles are caused by changes in aggregate (overall) demand and that such cycles can and should be influenced by fiscal and monetary policy undertaken to promote economic stability.

Keynesian Economics Developed by John Maynard Keynes (1930s) “Demand Side Economics” Developed by John Maynard Keynes (1930s) Government can help struggling economies by spending money (in the short term) This would create more demand for goods Businesses would increase production AND… Employment would increase First used in US by President FDR to fight Depression in 1930s

Keynesian Economics Developed by John Maynard Keynes (1930s) “Demand Side Economics” Developed by John Maynard Keynes (1930s) Proponents say: When the economy is struggling, people/businesses need a kick start to get them buying, and the government can provide that by putting money into the economy (social programs, buying goods, etc.) Opponents say: That is okay in the short term, but once a government program is started to help people, it never gets taken away, which leads to bigger issues for the economy.

Supply-Side Economics Developed by Milton Friedman (1980s) DEFINITION: Policy intended to increase an economy’s productive capacity by shifting aggregate supply: e.g, a tax cut giving businesses an incentive to invest and expand.

Supply-Side Economics Developed by Milton Friedman (1980s) He opposed Keynesian economics He argued Govt needs to focus on cutting their budgets Govt needs to focus on cutting taxes Economic growth set by willingness of producers to produce Willingness to produce comes from making more money More money comes from lower taxes Ronald Reagan used in 80s to fight 70s recession

Supply-Side Economics Laffer Curve Govt Revenue will increase UNTIL People are taxed too much as taxes increase… You can only tax people/business so much before they stop working or trying to produce !

Supply-Side Economics Developed by Milton Friedman (1980s) He opposed Keynesian economics Proponents say: Reducing taxes gives businesses/people more money to spend increasing demand for goods which will provide jobs and a growing economy Opponents say: Reducing taxes will cut government revenues which will lead to deficits or cuts in services for people. Additionally, tax cuts may only help those who make the most money.

The National Debt So, what if you continue to increase government spending and can not afford to continue to raise taxes?!? For decades the national government’s yearly budget spends more money than it brings in revenue How does the government make up the difference? BORROWING !! sells Treasury Bills (matures in 26 weeks or less) sells Treasury Notes (matures from 2 to 10 years) sells Treasury Bonds (matures in 30 years) Current National Debt

The National Debt – for yr 2014 Where the money comes from: Individual Income Tax: $1.39 trillion Corporate Income Tax: $320 billion Corporate Payroll Tax: $1.02 trillion Social Security, Medicare, etc. Excise Taxes: $93 billion Taxes on specific goods…gas, tobacco, etc. Other Taxes: $189 billion Tariffs, estate and gift taxes, etc. Total Revenue $3.02 trillion Where the money goes: Defense: $603 billion Social Security: $850 billion Medicare/aid: $511 billion Interest on debt: $228 billion Federal Pensions: $150 billion Total Spending $3.51 trillion Income Security: $514 billion Unemployment, Welfare, etc Other: $658 billion “Servicing the Debt” : Paying the interest on the debt Deficit $484 billion Data generated from Office of Management and Budget (https://www.whitehouse.gov/omb/budget/Historicals/)

The Debt Ceiling By law, the Federal Government can only borrow so much money each year (as approved by Congress). Once it reaches that limit it can no longer borrow money. If it cannot borrow money needed to cover the budget, then spending will have to be cut immediately. That may mean people do not get paid, programs have to be cut and/or those that loaned us money will not get paid. Show video: “Debt Ceiling, Explained”

The Debt Ceiling The debt ceiling has been raised 15 times since 2000. What does this mean for our economy? Show video: Debt Limit