Introduction to Economics: Social Issues and Economic Thinking Wendy A. Stock PowerPoint Prepared by Z. Pan CHAPTER 23 FISCAL POLICY AND THE FEDERAL BUDGET Copyright © 2013 John Wiley & Sons, Inc. Photo Credit: © Dieter Spears/iStockphoto

 Summarize how the federal budget is allocated  Describe how the government raises money through taxes and borrowing  Explain the difference between government deficits and debts  Illustrate how fiscal policy impacts the economy using an aggregate demand and aggregate supply model  Assess the tradeoffs associated with fiscal policy Copyright © 2013 John Wiley & Sons, Inc. 2 AFTER STUDYING THIS CHAPTER, YOU SHOULD BE ABLE TO:

 Nondiscretionary Spending is determined by current obligations, policies, and demographics, rather than by policymaker discretion. (about 60%)  Discretionary Spending is determined by policymaker choices. (about 40%) Copyright © 2013 John Wiley & Sons, Inc. 3 FEDERAL BUDGET – SPENDING

Copyright © 2013 John Wiley & Sons, Inc. 4 FEDERAL SPENDING BY CATEGORY

Copyright © 2013 John Wiley & Sons, Inc. 5 FEDERAL SPENDING BY CATEGORY

 Tax is a financial obligation placed on taxpayers.  Income Taxes are taxes that are based on the amount of income a taxpayer earns.  Progressive Income Tax System – As taxpayers’ incomes increase they are required to pay a larger percentage of that income as taxes. Copyright © 2013 John Wiley & Sons, Inc. 6 FEDERAL BUDGET – REVENUE

Copyright © 2013 John Wiley & Sons, Inc. 7 FEDERAL REVENUE BY CATEGORY

Copyright © 2013 John Wiley & Sons, Inc. 8 FEDERAL REVENUE BY CATEGORY

 Income Tax Bracket is a level of income that is taxed at a different marginal tax rate.  Marginal Tax Rate is the tax rate on income within a tax bracket. Copyright © 2013 John Wiley & Sons, Inc. 9 FEDERAL BUDGET – REVENUE

Copyright © 2013 John Wiley & Sons, Inc. 10 INCOME TAX BRACKETS AND TAX RATES

To make up the difference between the spending and tax revenue, the federal government also borrow huge amount of money ($919 billion in 2012, the third largest source of federal revenue).  Two primary sources:  from the public (U.S. Savings Bonds, T-Bills, T- Bonds, T-Notes)  from itself (e.g. Social Security Trust Fund) Copyright © 2013 John Wiley & Sons, Inc. 11 BORROWING

 Budget Deficit occurs when the amount of government spending in a given period is larger than the amount of government revenue from taxes and earnings during that period.  Budget Surplus occurs when the amount of government spending in a given period is less than the amount of government revenue from taxes and earnings during that period.  Federal Debt is the accumulated federal deficit borrowing that has not been paid off. Copyright © 2013 John Wiley & Sons, Inc. 12 FEDERAL DEFICITS AND DEBT

 Publically-held Debt is the portion of the federal debt that is owed to public lenders. (held by individuals, businesses, foreign governments, and other investors)  Government-held Debt is the portion of the federal debt that is owed to government agencies. (held by U.S. government agencies including Social Security Trust Fund, Federal Housing Administration, and federal employees’ retirement trust funds) Copyright © 2013 John Wiley & Sons, Inc. 13 FEDERAL DEFICITS AND DEBT

Copyright © 2013 John Wiley & Sons, Inc. 14 U.S. FEDERAL DEFICIT ($ MILLIONS)

Copyright © 2013 John Wiley & Sons, Inc. 15 U.S. FEDERAL DEBT ($ MILLIONS)

 Income Inequality  Foreign-Owned Debt  Dangerous Levels of Debt  Burden on Current and Future Generations  Crowding Out Effect Copyright © 2013 John Wiley & Sons, Inc. 16 CONTROVERSIES SURROUNDING FEDERAL DEFICITS AND DEBTS

 Income Inequality  Payments on the debt cause a transfer of income from taxpayers to debt holders.  Average U.S. taxpayer tends to have lower income than the average debt holder  Debt payment tends to transfer money from those with lower incomes to those with higher incomes. Copyright © 2013 John Wiley & Sons, Inc. 17 CONTROVERSIES SURROUNDING FEDERAL DEFICITS AND DEBTS

Copyright © 2013 John Wiley & Sons, Inc. 18 FOREIGN-OWNED DEBT

 Debt-to-GDP Ratio measures the size of a country ’s debt as a percentage of the country’s gross domestic product (GDP).  A high debt-to-GDP ratio indicates that a country would have a more difficult time paying back its debt.  Debt-ceiling is the congressionally mandated maximum amount of debt that the U.S. government can have. Copyright © 2013 John Wiley & Sons, Inc. 19 DANGEROUS LEVELS OF DEBT?

Copyright © 2013 John Wiley & Sons, Inc. 20 DEBT-TO-GDP RATIOS: A COMPARISON

 Trade-off between borrowing more and spending less (or tax more)  More borrowing implies a higher interest burden for the future generations.  Spending less (or tax more) means less benefits (or more burden) for the current generation. (spending on infrastructure could also affects future generations’ benefits) Copyright © 2013 John Wiley & Sons, Inc. 21 BURDEN ON CURRENT AND FUTURE GENERATIONS

Crowding Out occurs when government borrowing pushes up interest rates, which causes a reduction in private consumption and investment. Copyright © 2013 John Wiley & Sons, Inc. 22 CROWDING OUT EFFECT

 Fiscal Policy is the use of government spending and taxation to influence the economy.  Discretionary Fiscal Policy: When policymakers actively change government spending or taxation in response to changes in the economy.  Nondiscretionary Fiscal Policy: Automatic fiscal policy that stabilizes economic activity without active policy changes. Copyright © 2013 John Wiley & Sons, Inc. 23 FISCAL POLICY

Copyright © 2013 John Wiley & Sons, Inc. 24 AGGREGATE DEMAND/AGGREGATE SUPPLY MODEL

 Expansionary Fiscal Policy is used to increase aggregate demand.  Contractionary Fiscal Policy is used to decrease aggregate demand. Copyright © 2013 John Wiley & Sons, Inc. 25 EXPANSIONARY AND CONTRACTIONARY FISCAL POLICIES

Copyright © 2013 John Wiley & Sons, Inc. 26 EXPANSIONARY FISCAL POLICY

Copyright © 2013 John Wiley & Sons, Inc. 27 CONTRACTIONARY FISCAL POLICY

 Fiscal Policy Timing Lags  Recognition lag is the time between an actual change in economic activity and the ability for policymakers and others to recognize the change.  Administration lag is the time it takes for congress and the president to agree on what fiscal policy to use.  Response lag is the time it takes for government agencies to put fiscal policy into place.  Fiscal Policy and Politics Copyright © 2013 John Wiley & Sons, Inc. 28 CONTROVERSIES SURROUNDING FISCAL POLICY

QUESTIONS/DISCUSSIONS Copyright © 2013 John Wiley & Sons, Inc What are some examples of expansionary fiscal policy? What are some examples of contractionary fiscal policy? 2.Why might the government want to enact contractionary fiscal policy? Why might the government want to enact expansionary fiscal policy?

Copyright © 2013 John Wiley & Sons, Inc. 30 KEY CONCEPTS Nondiscretionary government spending Discretionary government spending Tax Income taxes Progressive income tax system Income tax brackets Marginal tax rate Budget deficit Budget surplus Federal debt Publically-held debt Debt-to-GDP ratio Debt ceiling Crowding out Fiscal policy Discretionary fiscal policy Nondiscretionary fiscal policy Expansionary fiscal policy Contractionary fiscal policy Recognition lag Administration lag Response lag