Transcript AP_Macro_Fiscal_Policy_Teacher

What is a Fiscal Policy?

Government spending and taxation to
achieve full employment without
inflation
©1999 South-Western College Publishing
Legislative Mandates

Employment Act of 1946
–
–
Federal Governments responsibility to ensure
price stability and full-employment
Utilize Fiscal and Monetary policy to achieve this
goal
Who decides to Tax or Spend??

The legislative branch – It is in the
Constitution – Article 1
–
The President proposes a budget each year
during the “State of the Union address”.
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
Congress approves/denies some or all of the budget.
Increases or decreases in Taxes must be passed by the
House of Representatives.
Everyone has a budget – even the
Federal Govt.
Revenues = Spending
Balanced Budget
Revenues > Spending
Budget Surplus
Revenues < Spending
Budget Deficit

Revenues mainly from Taxes. Some comes from Tariffs,
fees, and other levies on goods and services
Americans are living longer
and having fewer children
Consequently, fewer workers are available
to support each Social Security recipient
1960: 5.1 to 1
Today: 3.3 to 1
2040: 2 to 1
Source: Social Security Administration, March 2006
Difference between Deficits and Debt



Deficit - when a budget is created and
spending is greater than revenues.
Debt - the accumulated borrowing to cover
deficits.
National Debt (estimate) - $8,981 Trillion.
Relevant Numbers on Federal Debt
August 24, 2007
Information comes from the
Concord Coalition
www.concordcoalition.org/iss
ues/feddebt/debt-facts.html
The National Debt:
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As of August 24, 2007, the total outstanding debt was $8.981 trillion, which is
approximately 65% of U.S. Gross Domestic Product. This amounts to a share
of over $29,000 per citizen.
The Congressional Budget Office (CBO) August 2007 baseline projects that the
national debt will exceed $10 trillion by 2010 and will reach $12.870 trillion in
2017
The national debt can be divided into $5.055 trillion of publicly held debt
(domestic and foreign), and $3.926 trillion of debt held by government accounts
(trust funds), the largest of which is Social Security.
Because trust fund debt is a matter of internal governmental bookkeeping,
economists focus on the publicly held debt. It is this number that reflects the
impact of federal borrowing on the economy and the budget.
Publicly Held Debt:


The publicly held debt is currently $5.055 trillion, a historic high in
nominal terms.
A more important measure of the debt is its size in relation to the
nation's economy, generally stated in terms of Gross Domestic
Product (GDP). In CBO's baseline projection, accumulated federal
debt held by the public will equal 36.4% of GDP in 2007.
Publicly Held Debt:
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Roughly 90 percent of the publicly held debt consists of marketable
securities--Treasury bills, notes, bonds, and inflation-indexed issues
(called TIPS). The remaining 10 percent comprises non-marketable
securities, such as savings bonds and securities in the state and local
government series, which are nonnegotiable, nontransferable debt
instruments issued to specific investors.
By 2017, CBO projects publicly held debt to equal 25.2% of GDP. If
materialized, this would be a post-World War II low. Previously, its
post-World War II high was 109% of GDP in 1946, and its post-WWII
low was reached in 1974 at 24% of GDP.
Publicly Held Debt:

Under the Government Accountability Office's (GAO) Long-Term
Budget Scenario, publicly held debt will be 62.7% of GDP by 2020 and
250.3% of GDP by 2040.
Foreign Holdings of Debt:


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As of June 2007, domestic investors owned 55% ($2.724 trillion) of
outstanding public debt and foreign investors held 45% ($2.219 trillion)
of outstanding public debt.
The amount of the debt held by foreigners is at a historic high. As of
June 2007, foreign investors held $2.219 trillion of Treasury Securities,
$1.469 trillion of which is held by official institutions.
As of June 2007, Japan and China were the two largest foreign
holders of treasury securities with $612.3 billion and $405.1 billion
respectively
Foreign holdings of Treasury securities have increased by more than
$1.049 trillion since 2000.
Interest on the Publicly Held Debt:
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Every borrowed dollar carries an interest cost. The most direct
impact of public debt on the federal budget is, therefore, the
amount of money taxpayers must come up with each year to
finance past borrowing.
According to the CBO August 2007 Baseline, net interest on the
publicly held debt in fiscal year 2007 is expected to equal $235
billion -- roughly 8.6% of the federal budget.
Spending for interest on the debt in fiscal year 2007 ($235
billion) is expected to equal 20.1% of all personal income tax
revenue and more than the entire federal share of the Medicaid
program in fiscal year 2007 ($192 billion).
Interest on the Publicly Held Debt:
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
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During the 1980s and 90s, before the 1998-2001
surpluses, interest regularly consumed 13 percent or
more of the federal budget a year, reaching a high
point of 15.4 percent in 1996.
For fiscal year 2007, net interest on the publicly held
debt is expected to equal 1.7 percent of GDP. Its
recent high point was 3.3 percent of GDP in 1991.
Under GAO's long-term budget scenario, net interest
costs will reach 2.9% of GDP by 2020 and 11.6% of
GDP by 2040.
Trust Fund Debt:
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While trust fund debt does not have the same economic and budgetary
effects as publicly held debt, it is nevertheless a relevant, if
incomplete, indicator of future burdens such as Social Security,
Medicare and federal government pension payments.
As explained by the GAO: "Because debt held by the trust funds is
neither equal to future benefit payments, nor a measure of the
commitments of the current system, it cannot be seen as a measure of
this future burden. Nevertheless, it provides an important signal of the
existence of this burden." [1]
As a technical matter, trust fund balances are credited with interest.
However, trust fund interest is simply a credit of IOUs to the respective
trust fund. It does not involve an outlay of federal dollars and thus has
no economic or budgetary effect.
Trust Fund Debt:

According to the July 2007 Monthly Treasury Statement, the
five largest trust funds are:
–
Social Security's Federal Old Age and Survivors Insurance,
$1.965 trillion.
–
Civil Service Retirement, $677 billion.
–
Department of Health and Human Services Federal Hospital
Insurance, $320 billion.
–
Social Security's Federal Disability Insurance, $210 billion.
–
Military Retirement Fund, $194 billion
Gross Debt and the Statutory Limit:
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The debt subject to limit is the maximum amount of
money the government is allowed to borrow without
receiving additional authority from Congress.
The current statutory debt limit is $8.965 trillion.
Congress has approved three increases in the
statutory debt limit totaling $3.015 trillion since 2002.
The most recent legislation adopted by Congress
provided for an additional $781 billion increase in the
debt limit
National Debt
What is the Federal Budget today?
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http://www.heritage.org/Research/Budget/upl
oad/83722_1.pdf
Two types of Fiscal Policies of
Spending and Taxation

Discretionary Fiscal Policy
–
–
Changes in Taxes or Spending at the “option” of the Federal
Government.
These changes do not occur automatically- they must be
legislated.


Spending on the War on Terrorism, poverty programs, Student
financial aid, Homeland Security, etc.
Tax cuts for the “wealthy”, Capital gains taxes, change in
Social Security/Medicare taxes
Discretionary Spending 08’

Go to this website for interactive poster
www.thebudgetgraph.com/poster/
The Two types of Fiscal Policies
Spending and Taxation

Nondiscretionary Fiscal Policy
–
–
Built-in stabilizers -automatic changes in G and T as the economy
changes.
These do not require new legislation – already embodied in law

Examples: Unemployment Compensation, Food Stamps, Social
Security, Medicare
Progressive Tax System
 In a Recession– Incomes decline and people pay less of there income
in taxes - retain more to spend
 During periods of Inflation, as incomes rise people pay more of their
income in taxes – now they have LESS to spend

–
In a Recession – Government spending for some programs INCREASES. As the
economy improves, spending for these programs DECREASES
Mandatory spending is
consuming a
growing share of the budget
1965
1985
27%
66%
44%
2006
42%
38%
54%
7%
14%
Mandatory
Net Interest
8%
Discretionary
Source: Congressional Budget Office, October 2006
NOTE: Numbers may not add up due to rounding.
Change in composition of
discretionary spending
1965
1985
34%
39%
66%
61%
Defense
2006
50%
50%
Non-defense
Source: Congressional Budget Office, October 2006
Non-Discretionary Spending
Insert Progressive Tax Schedule
U.S. Tax Brackets-2006
Single Taxpayer
Rate
$0-$7,550
10%
$7,551-$30,650
15%
$30,651-$74,200
25%
$74,201-$154,800
28%
$154,801-$336,550
33%
$336,551-and above
35%
Progressive Tax Structure and You
What this means…
U.S. Tax Brackets-2006
If you do your taxes and after Credits and
Deductions your Adjusted Gross Income is
$100,000 (pretty good, huh!)
Single Taxpayer
Rat
e
$0-$7,550
10%
$7,551-$30,650
15%
$30,651-$74,200
25%
$74,201-$154,800
28%
$154,801-$336,550
33%
$336,551-and
above
35%
On your first 7,550 you pay 10%
From $7551 to $30,650 you pay 15%
From $30,361 to $74,200 you pay 25%
From $74,201 to $100,000 you pay 28%
Total Federal Income Tax
You are in the 28% Tax Bracket, BUT your
Effective Tax Rate is 22.40%
= $755
=$3,465
= $10,960
= $7,224
$22,404
Who bears the burden of Federal
Income Taxes??
Percentiles
Ranked by AGI
Adjusted Gross Income
Threshold on Percentiles
Percentage of Federal
Personal Income Tax Paid
Top 1%
Top 5 %
Top 10%
Top 25%
Top 50%
Bottom 50%
$364,657+
$145,283
$103,912
$62,068
$30,881
< $30,881
39.38%
59.67%
70.30%
85.99%
96.93%
3.07%

How many days do we work to pay our
taxes?

www.taxfoundation.org/taxfreedomday/
What is a
Recessionary Gap?

The amount by which Aggregate Demand falls short of
a full employment equilibrium, thus giving high
unemployment
©1999 South-Western College Publishing
AggregateDemand/Aggregate Supply
Recession
(Fe)
(AS)
SRAS
P
r
i
c
e
L
e
v
e
l
P(1)
(AD)
GDP1
Full Employment (Fe)
LRAS
Gross Domestic Product
Recessionary
Gap
Fiscal policy to help solve a
recessionary gap




Raise government spending
Lower taxes
Attempting to expand or stimulate the economy
Remember, multiplier effects
 “EXPANSIONARY”
REMEMBER
We want to get Aggregate Demand moving to the Right – Increasing GDP
AD
What is an
Inflationary Gap?

The amount by which Aggregate Demand exceeds the
full employment equilibrium, thus a booming
economy, leading to demand pull inflation.
©1999 South-Western College Publishing
AggregateDemand/Aggregate Supply
Inflation
(Fe)
P
r
i P(1)
c
e
(AS)
SRA
S
Inflationary Gap
(AD)
L
e
v
e
l
This is where we want
to be!!
Full Employment (Fe)
LRAS
Gross Domestic Product
Fiscal policy to help solve an
inflationary gap



Lower government spending
Raise taxes
Attempting to contract or slow down the economy
– “CONTRACTIONARY”
REMEMBER
We want to get Aggregate Demand moving to the Left (down) – Increasing GDP
AD
If the government is looking to close an inflationary gap, which
would be the preferred method?
A.
B.
C.
D.
E.
Lower taxes and increase govt. spending
Raise taxes and increase govt. spending
Lower taxes and decrease govt. spending
Lower taxes and don’t change govt.
spending
Raise taxes and decrease govt. spending
If the government is looking to close a recessionary gap,
which would be the preferred method?
A.
B.
C.
D.
E.
Lower taxes and increase govt. spending
Raise taxes and increase govt. spending
Lower taxes and decrease govt. spending
Lower taxes and don’t change govt. spending
Raise taxes and decrease govt. spending
“Crowding Out” Effect

Government INCREASES spending
WITHOUT raising taxes to pay for this new
spending
Where does this money come from?
“Crowding Out” Effect

Government must borrow this money

Government enters:
“The Market for Loanable Funds”

–
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Not an actual place – represents the total demand (from C, I, G,
foreigners) for money in the financial system and the total supply
of funds (from C, I, G, foreigners)
Competes for funds along with individuals, business and other
governments
–
What effect does this have on the Interest Rate?”
“Crowding Out” Effect
MARKET FOR LOANABLE FUNDS
“Crowding Out” with addition of “G”
S.L.F (C+I)
Real Interest
Rate
i1
i*
D.L.F. (C + I + G)
D.L.F (C + I)
Q*
Q1
Quantity of Loanable Funds
“Crowding Out” Effect

Follow the reasoning:
–
–
–
–
Government borrows money to increase spending –
Aggregate Demand INCREASES
Interest rate INCREASES due to “Crowding Out”
Adversely affects “C” and “I” – Aggregate Demand
DECREASES
Dollar APPRECIATES in value – Imports increase and
Exports decrease – Aggregate Demand DECREASES
WHAT IS THE NET EFFECT ON THE ECONOMY???