1. Session 11 Fiscal Policy
Disclaimer: The views expressed are those of the presenters and do not necessarily reflect those of the Federal Reserve Bank of Dallas or the Federal Reserve System.

2. TEKS
(15) Economics. The student understands the economic impact of fiscal policy decisions at the local, state, and national levels. The student is expected to:
(A) identify types of taxes at the local, state, and national levels and the economic importance of each;
(B) analyze the categories of revenues and expenditures in the U.S. federal budget; and
(C) analyze the impact of fiscal policy decisions on the economy.
(6) Economics. The student understands the basic characteristics and benefits of a free enterprise system. The student is expected to:
(D) analyze the costs and benefits of U.S. economic policies related to the economic goals of economic growth, stability, full employment, freedom, security, equity (equal opportunity versus equal outcome), and efficiency.

3. Teaching the Terms

4. Fiscal Policy Government spends money to provide goods and services
Government pays for those expenditures through taxation and borrowing

5. Externalities
Benefits or costs from a transaction extend beyond the buyer or seller
Positive externalities
Education
Technology spillovers or patent protection
Negative externalities
Pollution

6. Potential Market Failures
Rival in Consumption?
Yes No
Excludable?
Private Goods
Natural Monopolies
Common Resources
Public Goods

7. Catagorize Cable TV Clothing Fish in the ocean
Congested non-toll roads
Ice cream
Congested toll roads
National defense
Environment
Tornado siren
Fire protection
Uncongested non-toll roads
Uncongested toll roads

8. Rival in Consumption?
Yes No
Excludable?
Private Goods
Clothing
Congested non-toll roads
Ice cream
Natural Monopolies
Fire protection
Cable TV
Uncongested toll roads
Common Resources
Fish in the ocean
Environment
Congested toll roads
Public Goods
Tornado siren
National defense
Uncongested non-toll roads

9. Potential for Market Failure
Public goods are subject to a free-rider problem
Lighthouse, basic research
Common resources can lead to the tragedy of the commons
Clean air and water, congested cities
Role of property rights

10. Federal Government: Receipts
Individual income taxes
Social insurance taxes
Corporate income taxes
Other

11. Federal Government: Spending
Social Security
National defense
Income security
Medicare
Health
Net interest
Other

12. Federal Government Revenue
Source: Final Monthly Treasury Statement for FY2009

13. Federal Government Funding
Source: Final Monthly Treasury Statement for FY2009

14. Federal Government Expenditures
Note: “Other” includes many agencies, such as Transportation, Housing and Urban Development, Education, Homeland Security, Justice, Energy, State, NASA, International Assistance Programs, Interior, Commerce, EPA and Corps of Engineers
Source: Final Monthly Treasury Statement for FY2009

15. State Government Revenue

16. Texas Revenue
Insurance trust includes unemployment, retirement and workers comp funds In

17. State Government Expenditures

18. Texas Expenditures

19. Local Governments Revenue
Table 444

20. Local Government Expenditures

21. Structure of Taxes Regressive % of income paid in taxes ↓ as income ↑
Progressive
% of income paid in taxes is fixed as income changes
Proportional

22. Structure of Taxes Regressive Sales tax, Social Security taxes
U.S. federal income tax, estate taxes
Progressive
Flat tax, Medicare tax
Proportional

23. Budget Lingo Balanced budget Revenues = Expenditures Budget deficit
Budget surplus
Sum of all deficits – Sum of all surpluses
Government debt

24. Deficits and Debt
Government must borrow money when it runs a budget deficit
Government borrows from
Individuals
Corporations
Financial institutions
Foreign entities or foreign governments

25. Fiscal Policy and Economic Goals
National economic goals include
Growth
Stability
Full employment
Freedom
Security
Equity
Efficiency
Using government spending and taxation programs to achieve goals

26. What is the Goal? Taxes Capital gains Tariffs Deductions
Mortgage interest
Student loan interest
Charitable donations
Spending
Social Security
NASA
Food stamps
Defense Spending

27. Business Cycle
Real GDP
Time
Long Run Growth Trend
Recession
Expansion

28. Full Employment Level of Output
Price Level
Real GDP YF
Full Employment Level of Output
Aggregate Supply
PL1
Aggregate Demand

29. Expansionary Fiscal Policy
Response to a recession (economy is operating below full employment)
Seeks to stimulate production (and consumption)
Directly (expenditures ↑)
Indirectly (taxes ↓ to encourage household spending or investment spending)

30. Fiscal Responses to 2008 Recession
Emergency Economic Stabilization Act of 2008
Established the Troubled Assets Relief Program (TARP)
American Recovery and Reinvestment Act of 2009
Renewable energy and weatherize buildings
New infrastructure (roads, bridges, and mass transit)
Fund Pell Grants
Making Work Pay tax credit and Child Tax Credit

31. Contractionary fiscal policy
Response to inflation (economy is operating above full employment and prices are rising)
Seeks to reduce production (and consumption)
Directly (expenditures ↓)
Indirectly (taxes ↑ to discourage household or investment spending)
Politically difficult

32. Measuring Fiscal Policy’s Effects
Effects are not limited to the initial dollar value of the change in policy
The eventual effects may be larger or smaller, depending on:
Multiplier effect
Crowding-out effect

33. Multiplier Effect
Spending and tax policies create a chain reaction in the economy as people spend new income
Many factors complicate the multiplier
Taxes
International trade
Differing consumption patterns among various segments of the population
A reduction in taxes works in much the same way
Personal income tax cut of $20M leads to new consumption of $16M ($20M * .8)
Total increase in GDP of $80M ($16M * 5)
Total impact is smaller – initial tax cut (the first $20M) does not affect GDP; only counts consumption rounds
Taxes and international trade complicate the reality of the multiplier
Various segments of the population have a differing willingness to spend new income. Therefore, tax reductions, transfer payments and spending programs will multiply through the economy differently depending on the targeted group.

34. Crowding Out
Investment or consumption spending that is lost because government borrowing drives up interest rates
Government is entering the same market for funds as investors
If government saves less (a smaller surplus) or borrows more (a deficit), the loanable funds market will be impacted

35. Two Types of Fiscal Policy
Discretionary fiscal policy
Policymakers change tax policies or spending programs in response to fluctuations in the business cycle (at their discretion)
Automatic stabilizers
Implemented without any deliberate action from policymakers
Found in the tax system and spending programs

36. Automatic Stabilizers – Tax System
Taxes are linked to economic activity
Progressive income tax rates (individual and corporate)
Payroll taxes
Sales and excise taxes
Recessions → automatic “tax cut”
Expansion → automatic “tax increase”

37. Automatic Stabilizers – Spending
Government spending responds to the business cycle
Unemployment insurance benefits
Welfare benefits
School lunch programs
Other income-support programs
Recessions → more spending
Expansion → less spending

38. Challenges Related to Fiscal Policy
Political factors
Time lags
Time required to create and pass legislation
Time required to implement legislation
Supply side impacts
Forecasting difficulties
Monetary policies may reinforce or offset fiscal policies

39. Questions?