2. Chapter 6 – The Role of Government ECONOMICS THEORY AND PRACTICE Seventh Edition Copyright © 2004 John Wiley & Sons, Inc. All rights reserved. Patrick J. Welch St. Louis University Gerry F. Welch St. Louis Community College at Meramec & PowerPoint Presentation by: Dr. Ray Everett Pima Community College

3. Role of Government in the Macroeconomy Contents Expenditures & Revenues Fiscal Policy Government Budgets National Debt

4. Role of Government in the Macroeconomy Chapter Objectives To identify the major types of expenditures and the major sources of revenue of the federal, state, and local governments. To distinguish among progressive, proportional, and regressive taxes. To discuss recent tax issues and reforms. To introduce fiscal policy, explain its mechanics, and differentiate between discretionary and automatic fiscal policy. To define a surplus, balanced, and deficit budget, and identify the economic impact of each. To explain the relationship between the federal budget and fiscal policy. To discuss some realities of fiscal policy and the budgetary process that can hamper the attainment of fiscal policy objectives. To define the national debt, explain its financing, size, and burden on taxpayers, and introduce crowding out.

5. Government Expenditures Overview Government Expenditures & Revenues 6-1a TABLE 6-2 Total, Federal, and State and Local Government Expenditures, and Total Government Expenditures as a Percentage of GDP, Selected Years 1979-2000 (Billions of Dollars)

6. Categories of Government Expenditures  Government purchases of goods & services Government spending on new goods and services. Public Good –Good or service provided for all of society. Quasi-Public Good –Government-provided good that could be sold in a private market.  Transfer Payments Money from the government for which no direct work is required in return.  Interest paid on borrowed funds  Grants-in-aid to state and local governments Government Expenditures & Revenues 6-1b

7. Categories of Government Expenditures (cont.) Government Expenditures & Revenues 6-1c

8. Government Revenues Overview Government Expenditures & Revenues 6-1d

9. Government Revenues Overview (cont.) Government Expenditures & Revenues 6-1e

10. Sources of Government Revenue  Social Insurance Program Contributions from an individual’s wages are made to a fund from which that individual may draw when eligible for benefits. Government Expenditures & Revenues 6-1f

11. Progressive, Proportional, & Regressive Taxes  Progressive Tax Tax reflecting a direct relationship between the percentage of income taxed and the size of the income. –As income increases, so too does the rate at which that income is taxed, and vice versa.  Proportional Tax Also called a flat tax. Tax equal to the same percentage of income regardless of the size of the income. –As income increases or decreases, the rate at which that income is taxed remains constant.  Regressive Tax Tax reflecting an inverse relationship between the percentage of income taxes and the size of the income. –As income increases, the rate at which that income is taxed decreases, and vice versa. Government Expenditures & Revenues 6-1g

12. Tax Reform & Issues  Tax Reform Changes in tax policies and structures.  Tax Bracket Indexation Policy of adjusting income tax brackets to account for inflation.  Tax Reform Act of 1986 Major legislation that changed federal income tax exemptions, deductions, brackets, and rates.  Tax Base Particular thing on which a tax is levied.  Tax Rate The amount that is levied on the base.  Tax Abatement Policy of reducing or eliminating a tax that would normally be charged. Government Expenditures & Revenues 6-1h

13. Fiscal Policy  Influencing the levels of aggregate output and employment or prices through changes in federal government purchases, transfer payments, and/or taxes. Mechanics of Fiscal Policy (Examples)  Unemployment due to a decline in spending can be resolved by any or all of the following: Increasing government purchases of goods and services Increasing transfer payments Decreasing taxes  Demand-pull inflation from too much spending can be resolved by any or all of the following: Decreasing government purchases of good and services Decreasing transfer payments Increasing taxes Fiscal Policy 6-2a

14. Types of Fiscal Policies  Discretionary Fiscal Policy Deliberate changes in government expenditures and/or taxes to control unemployment or demand-pull inflation.  Automatic Fiscal Policy Also called automatic stabilization. Changes in government expenditures and/or taxes that occur automatically as the level of economic activity changes. –Helps to control unemployment or demand-pull inflation. Fiscal Policy 6-2b

15. Types of Fiscal Policies (cont.) Fiscal Policy 6-2c TABLE 6-5 Fiscal Policy Summary

16. Types of Budgets  Balanced Budget Government’s total expenditures equal its total revenues.  Surplus Budget Government’s revenues are greater than its expenditures.  Deficit Budget Government’s expenditures are greater than its revenues. Government Budgets 6-3a

17. Types of Budgets (cont.) Government Budgets 6-3b TABLE 6-6 Federal Budget Receipts, Outlays, and Surpluses or Deficits for Fiscal Years 1940–2002 (Billions of Dollars)

18. Types of Budgets (cont.) Government Budgets 6-3c TABLE 6-6 (continued)

19. Beyond the Budget Figures  Unified Budget Budget that assembles all federal government receipts and outlays, and the resulting overall deficit or surplus, in one report.  Trust Fund Restricted fund. –Payments from this fund are specified as to recipients and/or uses.  Entitlement Programs set up by the government to pay benefits to people who meet the eligibility requirements of the programs.  On-Budget/Off-Budget Categories of the unified budget established by Congress. –Generally refers to programs that have immediately controllable and noncontrollable receipts and expenses. Government Budgets 6-3d

20. Beyond the Budget Figures (cont.) Government Budgets 6-3e TABLE 6-7 Federal Government Unified, On-Budget, and Off-Budget Balances, 1990–2002 (Billions of Dollars)

21. Budget & Fiscal Policy Summary  Surplus Budget Dampens aggregate spending and can aid in managing demand-pull inflation.  Deficit Budget Increases aggregate spending and can help to reverse a recession.  Balanced Budget Can slightly expand the economy. Government Budgets 6-3f

22. National Debt Overview  Accumulated total debt of the federal government due to deficit spending. National Debt 6-4a

23. National Debt Overview (cont.) National Debt 6-4b

24. Financing the National Debt  U.S. Treasury Security Issued by the federal government in return for funds lent to it. –Largest portion of the national debt is held by private investors, and the rest is owned by the Federal Reserve Banks, government agencies, and trusts. Assessing the National Debt  Debt Service Cost of maintaining a debt. –Generally measured in interest costs.  Crowding Out Occurs when borrowing by the federal government reduces borrowing by households and businesses. National Debt 6-4c

25. Assessing the National Debt (cont.) National Debt 6-4d FIGURE 6-2 National Debt as a Percentage of GDP, 1970–2000

26. ECONOMICS THEORY AND PRACTICE Seventh Edition Copyright © 2004 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the expressed written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Chapter 6 – The Role of Government This is the end of Chapter 6. To return to the contents menu of this chapter, click on the menu graphic to the right of this text. To begin Chapter 7, click on the next chapter icon to the right of this text. Menu Next Chapter