Macroeconomics, Part II Government Taxation and Spending, or Why Never to Give a Congressman Your Debit Card

Types of Taxes Progressive – As incomes rise, the % of income one pays in taxes also rises – Ex. – the federal income tax Regressive – As incomes rise, the % of income one pays in taxes decreases – Ex. – the state sales tax Proportional – People pay the same % of income in taxes regardless of income

200, ,000 $50,000 % of income tax % of income tax % of income tax income 30%60,000 25%25,000 20% $10,000 progressive 25%50,000 25%25,000 25% $12,500 proportional 20% $40,000 25% $25,000 30% $ 15,000 regressive Examples of the Three Tax Systems

Major Sources of Gov’t Revenue City - property taxes State – state sales tax Federal – individual income taxes What does the Federal gov’t spend most of its money on? 1.Medicaid/Medicare 2.Social Security 3.Defense/Wars

Questions About the National Debt What is the national debt? What caused the national debt? Where does the government get the money when it wants to spend more than it takes in? What is a budget deficit? What is a budget surplus? Is a budget deficit the same as a trade deficit?

Fiscal Policy Def. – The use of government spending and taxation to influence the economy – Carried out by the POTUS and Congress through the budgeting process

Demand-Side Fiscal Policy Focuses on increasing AD in order to increase real GDP. Hero of demand-side economics is John Maynard Keynes – Argued that in times of recession or war, gov’t is the only economic actor willing and able to boost spending – Therefore it may make sense to borrow $ to boost gov’t spending in order to stimulate the economy GDP = C + I + G + NX

The Multiplier Effect Idea that $1 of gov’t spending adds more than $1 to the economy. Ex. – – Gov’t spends money to build a bridge … – Construction workers earn more income … – They spend their income at various businesses … – Business revenue increases … – Businesses may boost their supply by expanding and hiring more workers … – These new workers now have more money to spend … So an increase in G leads to an increase in C, which leads to an increase in I. GDP rises by a level greater than the initial increase in G. Economy stimulated.

Laffer Curve High revenues Low revenues 100% High taxes 0% Low taxes 50% Tax revenues Tax rate a b c Supply-Side Economics Supply-side economics stresses the influence of taxation on the economy. Supply-siders believe that taxes have a strong, negative influence on output. The Laffer Curve shows how both high and low tax rates can produce the same tax revenues.

Effects of Expansionary Fiscal Policy Total output in the economy High outputLow output High prices Low prices Price level Aggregate supply Original aggregate demand Lower output, lower prices Higher output, higher prices Aggregate demand with higher government spending Expansionary Fiscal Policies Increasing Government Spending If the federal gov’t increases its spending or buys more goods and services, it triggers a chain of events that raise output (GDP) and creates jobs. Cutting Taxes When the gov’t cuts taxes, consumers and businesses have more money to spend or invest. This increases demand and output.

Effects of Contractionary Fiscal Policy Total output in the economy High outputLow output High prices Low prices Price level Aggregate supply Higher output, higher prices Original aggregate demand Lower output, lower prices Aggregate demand with lower government spending Contractionary Fiscal Policies Decreasing Government Spending If the federal gov’t spends less, or buys fewer goods and services, it triggers a chain of events that may lead to slower GDP growth. Raising Taxes If the federal gov’t increases taxes, consumers and businesses have fewer dollars to spend or save. This also slows growth of GDP.