1. Fiscal Policy
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2. Fiscal Policy Defined
The government’s (Congress and the President) use of taxing and spending to promote economic growth and stability
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3. History of Fiscal Policy
Laissez-faire (classical economics)
The Great Depression 1929 – 1930’s
WWII
No need for government interference
Market regulates itself
Adam Smith, David Ricardo, Thomas Malthus are classical economists
Challenged classical economics
FDR increased government spending on programs to increase employment on public works to help stop the depression
To prepare for war, U.S. increased production of war goods.
Government spending increased dramatically which helped the country out of the depression.
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4. History of Fiscal Policy
JFK proposed tax cuts to personal and business income taxes to increase aggregate demand.
Government spending increased due to the Vietnam War.
Reagan passed a bill to reduce taxes by 25% over 3 years to fight stagflation (high unemployment + high inflation).
Demand-side policies would not work, thus supply-side policies were introduced – known as Reaganomics.
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5. Two Branches of Fiscal Policy:
Demand-side
Supply-side
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6. Demand-Side Economics
Inspired by John Maynard Keynes during the Great Depression and is also called Keynesian Fiscal Policy
Looks at changing aggregate demand which is either increasing or decreasing
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7. Tools of Fiscal Policy 1. Taxing Policy of Government
2. Spending Policy of Government
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8. Aggregate Demand is C + I + G + (F) = GDP
Changes in business (I) spending is the most volatile and this will cause the most economic instability. To offset this, the government can compensate by changing their taxing and spending to maintain a stable level of GDP.
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9. Demand-Side Fiscal Policy
Keynes said that sometimes the market could not correct itself and the government needs to take a more active role in the economy.
This increased role of government in the economy was something different from the classical view. It was considered very radical for the time.
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10. Limitations of Demand-Side Fiscal Policy
Not coordinated with monetary policy
Surplus budget unpopular and politicians lack the political will to carry it out
Time lags - inside lags and outside lags
People are unpredictable. Economics is a social science so we are dealing with human behavior.
Doesn’t solve stagflation
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11. Multiplier Effect
The multiplier effect in fiscal policy states that for every one dollar change in taxing or government spending, it will create a greater change in the national income, either increasing or decreasing.
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12. Fiscal Policy – Supply-Side
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13. Supply-Side Fiscal Policy
Economic policies designed to stimulate output (GDP) and lower unemployment. To achieve this you increase aggregate supply (AS).
Contemporary supply-side was implemented in the 1980’s to deal with stagflation and is sometimes called “Reaganomics.”
Goal is to give incentives to businesses to produce more ( AS).
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14. Principles of Supply Side
Tax cuts encourage consumers to save so businesses have money to borrow for capital investment.
Government spending cuts especially on transfer payments where nothing is produced
Deregulate business
Overall Less Government
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15. PL When AS increases - increase GDP Q AS1 AS2 AD Q1 GDP Q2
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16. PL When AS increases - price goes down Q AS1 AS2 P1 P2 AD
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17. Supply-Side Economics
Stresses the influence of taxation on the economy. Supply-siders believe that taxes have a strong, negative influence on output.
Arthur Laffer came up with a theory concerning tax rates and tax revenues. It was called the Laffer Curve. Laffer said if you lower the tax rate, we will see an increase in tax revenue.
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18. Laffer Curve A Tax 100% B R a t es C D E 0% Tax Revenues
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19. Laffer Curve
100%
Govt. will collect no revenue at two tax rates, 0% and 100%.
With 100% tax rate, workers lose all incentive to work (no disposable personal income) and at 0% tax rate the government will collect 0 revenue.
Tax
R a t es 0%
Tax Revenues
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20. Laffer Curve
100% A B
Tax
R a t es
As we move from A to B, tax rate is lowered and we increase tax revenue. C D E 0%
Tax Revenues
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21. Laffer Curve
100%
Point C is the optimum tax rate. Higher tax rates decrease worker incentives.
Below C we decrease the revenue.
PROBLEM: We don’t know where we are on the curve.
Tax
R a t es C 0%
Tax Revenues
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22. Limitations Lack of experience - hasn’t been around long enough
Don’t know where we are on Laffer Curve
Makes Federal Income Tax less progressive and reduces the automatic stabilization and reduces many “safety net” programs
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23. Deciding Fiscal policy
Taxing & Spending
Deciding Fiscal policy
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24. When the U.S. Government decides Fiscal Policy:
They are deciding which goal to address at a given time – economic growth, stability or full employment.
They must decide to tax or spend to address the problems in the economy.
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25. Taxation
Power to Tax – Article 1, Section 8, Clause 1 of the U.S. Constitution
16th Amendment
Limitations:
Purpose is for “the common defense and general welfare”
Federal taxes must be the same in every state
Government may not tax exports
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26. Purposes of Taxation Raise revenue
Regulate the economy (fiscal policy)
Redistribution of income (transfer payments)
Provide positive economic incentives
Provide negative economic incentives
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27. Types of Taxes or Tax Structures
Progressive - takes larger percent of income from higher income groups - as income goes up tax rate increases
example- Federal Income Tax
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28. Types - Regressive
Regressive - takes larger percent of income from the lower income group
Example - sales tax, property tax, Social Security tax
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29. Types - Proportional
Proportional - takes the same percent of income from all income levels
Examples - some state income taxes & proposed flat tax
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30. Principles of Taxation
1. Benefits received - people who directly benefit or use the good or service should pay
Example - Excise tax on gasoline used to build roads
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31. Example - Federal Income Tax
2. Ability-to-pay - people who have more wealth or income should pay more
Example - Federal Income Tax
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32. Top Federal Taxes Individual Income Tax Social Security
Corporate Income Tax
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33. Federal Taxes
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34. FICA FICA=Social Security + Medicare
FICA Taxable Wage Base or a cap - a maximum income level that can be taxed. All income above that level is not taxed for FICA, tax free.
Employers match employee contributions.
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35. State Taxes States receive most of their revenue from a sales tax.
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36. Local Taxes
Property Tax
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37. Who Bears the Burden of a Tax?
To fully evaluate the fairness of a tax, it is important to think about who bears the final burden of the tax or the incidence of a tax.
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38. Government Spending Goods and Services Transfer Payments
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