Transcript Public Expenditures and Fiscal Policy

Public Expenditures and Fiscal
Policy
“The only good budget is a balanced
budget.”
(Adam Smith)
Structure of lecture




Public expenditures
System of public budgets
State budget
Fiscal policy
Public expenditures
Public Expenditures
Government
Expenditures (G)
Transfers (Tr)
Private and Public sectors
Consumption
(C)
Investment
(I)
Private sector
T (Taxes)
Tr (Transfers)
Public Sector
G
Gov. consumption
(CG)
Gov. Investment
(IG)
Public expenditures classification
Public expenditures can be split into two
groups:
 Current expenditures for:





goods and services,
interest payments,
subsidies,
transfers.
Capital expenditures.
Macro-economical aspects of public
expenditures


Public expenditures are important part of total
incomes and expenses.
Public expenditures for goods and services
(G) = an important part of AD.

Remember?
AD (aggregate Demand)= Agg.Expenditure =C + IG + G + Xn


Trends of G influence employment and
production in the economy.
G could work as multiplier▼ in fiscal policy.
Multiplier theory by Keynes in-short


Each economic agent has marginal propensity to consume (MPC)
and to save (MPS). Say, Mr. Smith leaves 25% of income in a bar
(MPC=0,25), so his MPS=0,75.
Let’s analyse what will happen to the money spent:



(1)Mr. Smith’s extra income is 1000CZK
Mr. Smith spends 25% of 1000CZK (=250CZK) in a bar
(2)Mr. Black (bar-keeper) receives extra income of 250CZK
Mr. Black spends 25% of 250CZK (=63 CZK) in a neighbour bar
(3)Mr. White (neighbour-bar-keeper) receives extra 63CZK
Mr. White spends 25% of 63CZK (=16CZK) in another bar
…

(10) Mr. Brown (a drug-store keeper) receives extra 0,005CZK for selling
medicine against all the above gentlemen’s hangover.
Total income generated: 1334,33 CZK
Multiplier theory by Keynes in-short

The formula:
1
1
Multiplier 

1  MPC MPS

In our example:
1
1
Multiplier 

 1,33
1  0,25 0,75


Multiplier 1,33 means, that 1000CZK of money
injection will lead to 1000*1,33=1330CZK of generated
income.
So in the same manner the government uses
Multiplier Effect to lead to the growth of national
income and further growth of consumption, support
producers, etc.
Empirical fact: Public budgets are growing

„The public sector
grows with increasing
income per capita“
Alfred Wagner
(1835 – 1917)
Factors influencing growth of public
expenditures

demographic factors:










shift from self-sufficiency on farm with large family to urban mutual dependence,
age structure changes,
etc.
militant affairs,
inflation trends (higher costs for goods and services),
technological changes (increased labour productivity),
production volumes growth – increase of incoming taxes,
increasing consumption,
political and social influences,
etc.
Demographical factors: Population structure in
the CR by age group and sex in 1930
85+
80-84
75-79
70-74
65-69
60-64
55-59
50-54
45-49
40-44
35-39
30-34
25-29
20-24
15-19
10-14
5-9
0-4
men
women
600
400
200
200
Population (in 1930)
400
600
Population structure in the CR by age group
and sex in 1990
85+
80-84
75-79
70-74
65-69
60-64
55-59
50-54
45-49
40-44
35-39
30-34
25-29
20-24
15-19
10-14
5-9
0-4
men
women
600
400
200
200
Population (in 1990)
400
600
Size of the public sector as % of GDP
%
SVED.
RAK.
ITAL.
FR.
BELG.
U.K.
8 000
NOR.
CAN.
JAP.
6 000
SRN
10 000
AUST.
USA
12 000
GDP/cap. USD
14 000
System of public budgets



State budget,
Local budgets (regional, municipal),
Special centralized funds (i.e. in CR –
National Property Fund, Land Fund, Environmental
Fund etc.)
State budget
Local
budget 1
Local
budget 2
…
Local
budget N
State budget
Passes in a Parliament as a law.


The fact of approval law implies confidence in government
and its policy.
Budget is being approved for a Fiscal year
(= calendar year)




USA: September – September,
Japan: March – March,
UK: April –April.
Any budget has 2 parts:



Revenue side
Expenditure side
Income
1. Taxes
2. Duties
3. …
Expenditure
100
25
1. Medicare
2. Military
3. ...
13
200
Income side of the State budget

Direct taxes:






Indirect taxes:




taxes on persons or property,
individual income tax,
employee social insurance tax,
corporate tax,
property tax,
taxes on events or transactions,
employer payroll tax,
sales tax (including excise and value-added).
Other incomes for state budget:



Customs duties,
loans from abroad,
incomes from public offerings of state bonds
Indirect taxes
► are imposed by the government on producers - but the burden of
the tax can be passed onto consumers.

Indirect taxes can either be specified as
 value tax (i.e. as a percentage of the price of a good),
 as a unit tax (i.e. as a price per unit or per amount).

Indirect taxes consequences:
 increase in prices,
 limitation of final consumption.

Indirect taxes are better managed than direct taxes. Trend in
many countries: from direct to indirect taxes.

One of the main indirect taxes – value added tax (VAT).
Principles of taxation



Fairness, efficiency, purpose.
The benefits principle is the idea that people should pay taxes
based on the benefits they receive from government services.
(I.e. gasoline tax: revenues from a gasoline tax are used to
finance the highway system).
The ability-to-pay principle is the idea that taxes should be
levied on a person according to how well that person can
shoulder the burden:


Vertical equity (progressive and regressive system).
Horizontal equity (equal conditions).
State budget expenditures
► are the transfers and purchases of goods and services.
Transfers = financial flows from state budget to individual
subjects (firms and households).

Transfers to households: Social insurance, childern
allowances, unemployment allowances etc.

Transfers to firms: Capital and non-capital subsidies.
Govermental purchases of goods and services: capital and
non-capital.
Subsidies; 59; 5%
Interest
expenditure; 34; 3%
Capital formation;
138; 11%
Other; 45; 4%
Collective
consumption; 311;
25%
Social transfers;
639; 52%
State budget expenditures items by cascade
1.
social expenditures
2.
education
3.
administration (civil service)
4.
highway
5.
local governments
6.
defence expenditures
7.
security
8.
housing
9.
health service
10. support of agriculture and forest
11. personal railage
12. governmental reserve
13. culture
14. subsidies on heating
State budget: Result of the fiscal year



Balanced budget
Surplus budget
Deficit budget
Example: CZ budget for 2004
Components
Year 2004
Total revenue
1145
Total expenditure
1228
Deficit
-83
Deficit budget

Two types of deficits exist:



Cyclical deficit – related to the business cycle.
Structural (active) deficit – related to the measures of the
economic policy (taxation, volume of expenditures…).
State budget deficit compensation measures:


State bonds sale,
Loans from abroad.
Historical Developments which changed the
Role of Fiscal Policy
Development stages that bolstered the use of
fiscal policy



Influence of the General Theory by John Maynard
Keynes.
World War II--Evidence of positive effects of increased
aggregate demand.
Fiscal Policy: Objectives and Tools

Main objectives:





Balancing the budget (Pre-Great Depression)
Promoting full employment with price stability
(Post Keynes and WWII)
Eliminating critical points of economic cycles
Economical growth promotion
General tools:


Discretionary Fiscal Policy
Automatic Stabilizers
Expansive or Restrictive?


Expansive Fiscal policy – supports Aggregate
Demand growth and therefore the growth of total
output.
Restrictive Fiscal policy – is aimed to lessen the
inflation rate by the means of limiting both the
Aggregate demand and supply.
1. Tools of Discretionary Fiscal Policy
General tools:




Government purchases
Transfer payments
Taxes and Borrowing
Given a price level, what changes will increase the level
of real GDP? Other things being equal.


An increase in government purchases?
An increase in transfer payments?
Fiscal Policy basics
AD = C + I + G + (Ex-Im)
Fiscal policy points of AD influence:


G … governmental expenditures,
T … net taxes (they influence C).
Fiscal expansion – supporting the Aggregate Demand
growth.


directly – by increasing G,
indirectly – by increasing C (lessen the tax burden).

The main issue of the expansive fiscal policy
implementing is the budget deficit.
The same instruments are used by restrictive fiscal
policy.
How does an increase in government purchases
increase real GDP?

The Multiplier Effect in action
►The government increases its purchases. The aggregate
expenditure function shifts up.
► Increased government purchases increase real GDP.
► Increased real GDP increases disposable income.
► Increased disposable income increases consumption
(According to the marginal propensity to consume).
► Increased consumption increases real GDP (The cycle
continues).
How does expansionary fiscal policy actually
work?
► Shifts the AD curve up and to the
right.
P
AD1
► At the given price level P1,
demand exceeds supply. Excess
quantity demanded forces the
price level to rise.
P2
► As the price level rises, producers
will produce more and consumers P
1
will demand less - quantity
supplied increases, quantity
demanded decreases
► Price level rises until QD3 = QS3
► Output equals potential level and
economy is at both short-run and
long-run equilibrium
AD2
AS1
QD1 QD3QD2
Q
2. Automatic Stabilizers



Automatic Stabilizers stimulate AD during periods of
recession and dampen AD during periods of
expansion.
They do not require yearly congressional action to
operate.
Examples of automatic stabilizers:



progressive income tax with its increasing marginal income
tax rates,
unemployment insurance,
welfare spending.
Concerns about effectiveness of Fiscal Policy
1. Stagflation
 Situation: Economy is characterized by high inflation and high
unemployment rates that resulted from a decrease in
aggregate supply.
 Question: Why Was Fiscal Policy Not an Option in Eliminating
Stagflation?
 An increase in aggregate demand (Expansionary fiscal
policy) would force inflation.
 A decrease in aggregate demand (Contractionary fiscal
policy) would force unemployment.
2. The difficulty of estimating the natural rate of unemployment
Concerns about effectiveness of Fiscal Policy
3. The time lags involved in implementing fiscal policy may
weaken fiscal policy as a tool of economic stabilization. In the
case of an oncoming recession, it may take time to recognize
the coming recession, implement the policy and let the policy
have its impact.
4. Both automatic stabilizers and discretionary fiscal policy may
affect individual incentives to work, spend, save and
invest.
Examples:



effect of unemployment benefits on job search,
effect of changes in income taxes on labor supply,
effects of tax incentives on the types of investments.