Lecture Introduction to economics: Social issues and economic thinking: Chapter 23 - Wendy A. Stock

Chapter 23 - Fiscal policy and the federal budget. After completing this unit, you should be able to: 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,…

Introduction to Economics: Social Issues and Economic Thinking

Wendy A Stock

PowerPoint Prepared by

Z Pan

Chapter 23

Fiscal Policy and the Federal

Ø Summarize how the

federal budget is allocated

Ø Describe how the

government raises money

through taxes and

borrowing

Ø Explain the difference

between government

deficits and debts

Ø Illustrate how fiscal policy impacts the economy using an aggregate demand and aggregate supply model

Ø Assess the tradeoffs associated with fiscal policy

After studying this chapter, you should be

able to:

Ø Nondiscretionary Spending is determined by

current obligations, policies, and demographics, rather than by policymaker discretion (about

60%)

Ø Discretionary Spending is determined by

policymaker choices (about 40%)

FEDERAL BUDGET – spending

Federal Spending by Category

Federal Spending by Category

Ø Tax is a financial obligation placed on taxpayers.

Ø Income Taxes are taxes that are based on the

amount of income a taxpayer earns

Ø Progressive Income Tax System – As taxpayers’ incomes increase they are required to pay a

larger percentage of that income as taxes

FEDERAL BUDGET – revenue

Federal revenue by Category

Federal revenue by Category

Ø Income Tax Bracket is a level of income that is taxed at a different marginal tax rate.

Ø Marginal Tax Rate is the tax rate on income

within a tax bracket

FEDERAL BUDGET – revenue

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)

Ø Two primary sources:

Ø from the public (U.S Savings Bonds, T-Bills, T-Bonds, T-Notes)

Ø from itself (e.g Social Security Trust Fund)

Borrowing

Ø 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

Ø 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

Ø Federal Debt is the accumulated federal deficit borrowing that has not been paid off

FEDERAL DEFICITS AND DEBT

Ø 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)

Ø 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

FEDERAL DEFICITS AND DEBT

U.S Federal Deficit ($ millions)

U.S Federal Debt ($ millions)

Ø Income Inequality

Ø Foreign-Owned Debt

Ø Dangerous Levels of Debt

Ø Burden on Current and Future Generations

Ø Crowding Out Effect

Controversies Surrounding Federal Deficits

and Debts

Ø Income Inequality

Ø Payments on the debt cause a transfer of income from taxpayers to debt holders

Ø Average U.S taxpayer tends to have lower

income than the average debt holder

Ø Debt payment tends to transfer money from those with lower incomes to those with higher incomes.Controversies Surrounding Federal Deficits

and Debts

Foreign-Owned Debt

Ø Debt-to-GDP Ratio measures the size of a

country ’s debt as a percentage of the country’s gross domestic product (GDP)

Ø A high debt-to-GDP ratio indicates that a country would have a more difficult time paying back its debt.

Ø Debt-ceiling is the congressionally mandated

maximum amount of debt that the U.S

Dangerous Levels of Debt?

Debt-to-GDP Ratios: A comparison

Ø Trade-off between borrowing more and spending less (or tax more)

Ø More borrowing implies a higher interest burden for the future generations

Ø Spending less (or tax more) means less benefits (or more burden) for the current generation

(spending on infrastructure could also affects

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

Crowding Out effect

Ø Fiscal Policy is the use of government spending and taxation to influence the economy.

Ø Discretionary Fiscal Policy: When policymakers actively change government spending or

taxation in response to changes in the economy

Ø Nondiscretionary Fiscal Policy: Automatic fiscal policy that stabilizes economic activity without

FISCAL POLICY

Aggregate Demand/Aggregate

Supply Model

Ø Expansionary Fiscal Policy is used to increase aggregate demand.

Ø Contractionary Fiscal Policy is used to decrease aggregate demand

Expansionary and contractionary FISCAL

POLICIES

Expansionary Fiscal Policy

Contractionary Fiscal Policy

Ø Fiscal Policy Timing Lags

Ø Recognition lag is the time between an actual

change in economic activity and the ability for policymakers and others to recognize the change.

Ø Administration lag is the time it takes for congress and the president to agree on what fiscal policy to use.

Ø Response lag is the time it takes for government agencies to put fiscal policy into place.

Controversies Surrounding Fiscal Policy

1 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

• Discretionary fiscal policy

• Nondiscretionary fiscal policy

• Expansionary fiscal policy

• Contractionary fiscal policy

Recognition lag