Fiscal Policy Chapter 12

Federal Expenditures and Revenues Source: Economic Report of the President, 2004, tables B-1 and B-79. Note, recessions are indicated by shaded bars. 18% 20% 22% 24% Expenditures Revenues Deficits Federal Government Expenditures and Revenues (as a share of GDP) 2003

Fiscal Policy Government spending. Taxes. Under the control of the Treasury.

Budget Deficit The difference between government spending and tax revenues. Debt: accumulated deficit /

Spending Autonomous: the same regardless of the level of income Induced: dependent on the level of income

Rate of change of Y with a change in G where c is the marginal propensity to consume

Contractionary vs Expansionary Fiscal Policy Contractionary: cut spending, raise taxes, reduce deficit Expansionary: increase spending, lower taxes, increase deficit

Automatic Stabilizers Taxes. Unemployment insurance. Welfare.

The following quotation is from the mid-1980s by Paul Samuelson, a leading American Keynesian: “In the early stages of the Keynesian revolution, macro-economists emphasized fiscal policy as the most powerful and balanced remedy for demand management. Gradually, shortcomings of fiscal policy became apparent. The short- comings stem from timing, politics, macro- economic theory, and the deficit itself."

Increase in budget deficit Higher real interest rates Inflow of financial capital from abroad Decline in private investment Appreciation of the dollar Decline in net exports Crowding-Out in an Open Economy

Effect of a Tax Cut (T): Demand Side In the first round the addition to the GDP is c T. Multiply c T by the multiplier to get the total effect.

Effect of Tax Cut: Supply Side Increased incentive to produce, a lower cost of production.

The share of personal income taxes paid by the top one- half percent of earners is shown here. During the last four decades, the share of taxes paid by these earners has increased as the top tax rates have declined. This indicates that the supply side effects are strong for these taxpayers. 30 % 28 % 26 % 24 % 22 % 20 % 18 % % 14 % Share of personal income taxes paid by top ½ % of earners Top rate cut from 91% to 70% 1981 Top rate cut from 70% to 50% 1986 Top rate cut from 50% to 30% 1997 Capital gains tax rate cut Top rate raised from 30% to 39%