Transcript Chapter 20: The Government and Fiscal Policy

National Income and
Fiscal Policy
National Income : Basic Measures
Factors of production….labor, capital, land
GDP= sum of payments to labor, capital, land
and profits
˸Gross National Product (GNP)
GDP+ Net receipts from abroad made as factor
payments to
domestically
owned factors of production.
National Income : Basic Measures
•Net Domestic Product
=GDP minus depreciation
• NNP= NDP+ Net Receipts from abroad
•Net National Income
=NNP-Indirect taxes that Business pay
Government in the Economy
• Nothing arouses as much controversy as
the Role of government in the economy.
• Government can affect the Macro
economy through two policy channels:
fiscal policy and monetary policy.
• Fiscal policy is the manipulation of
government spending and taxation.
• Monetary policy refers to the behavior of the
RBI (Central Bank) regarding the nation’s
money supply.
Fiscal Policy
Changes in the expenditures or tax revenues
of the government, undertaken to promote
full employment, price stability and
reasonable rates of economic growth.
It refers to nation’s policy relating to the
government spending, taxing, borrowing
and debt management.
Objectives
• Mobilization of resources
• Acceleration of the economic growth
• To minimize the inequalities of Income and
Wealth.
Three main constituents of the fiscal
policy
• Taxation policy
• Public Expenditure policy
• Public debt policy
All these constituents must work together to
make the fiscal policy sound and effective
TAXATION POLICY
The main objectives for which taxes are
levied is to raise revenue by transferring
resources from the public to government
and the opposite applies when the
government cut the taxes so that some
resources are transferred from the
government to public.
It will depend on the tax system that how
much it has impact on the economy.
The characteristics of good tax system
are:
• Equity in distribution of tax burden
• It should yield a satisfactory amount for the
maintenance of a government.
• It should maximize social benefit that is
redistribution of wealth and reducing the
inequalities of income.
Therefore in the situation of recession the subsidies
and tax cuts will increase the disposable income
and hence increase the overall production of the
economy and vice versa.
Impact of Other policies
Public Expenditure
It is the most potent weapon to raise the
consumption and to increase the economic
growth. Increased government expenditure will
open new job opportunities in the economy, which
means creation of demand for goods and
services. It can lead to pump priming, which
means increase in private expenditure through an
injection of fresh purchasing power in the form of
an increase in public expenditure. Such
expenditure should be progressively raised in the
depression and reduced when the economy is
overheated.
Public Debt policy
In case of recession, the government can
reduce the public borrowing so that there
is more resources with the public to
increase the consumption.
Expansionary Fiscal Policy
• The government uses expansionary fiscal
policy to increase the amount of money
available to the general public. They do
this through lowering taxes and raising
government spending.
• An increase in government spending
and/or a decrease in taxes designed to
increase aggregate demand in the
economy, thus increasing real output and
decreasing unemployment.
Contractionary fiscal policy
• Increasing taxes and lowering government
spending. Decrease in government
spending and/or an increase in taxes
designed to decrease aggregate demand
in the economy and control inflation.
• This is applied when the economy needs
to decrease output or national income.
Government in the Economy
• Tax rates are controlled by the
government, but tax revenue depends on
changes in household income and the size
of corporate profits, which the government
cannot control.
• Discretionary fiscal policy refers to
changes in taxes or spending that are the
result of deliberate changes in government
policy.
Net Taxes (T), and Disposable Income (Yd)
• Net taxes are taxes paid by firms and
households to the government minus
transfer payments made to households by
the government.
• Disposable, or after-tax, income (Yd)
equals total income minus taxes.
Yd  Y  T
The Budget Deficit
• A government’s budget deficit is the
difference between what it spends (G) and
what it collects in taxes (T) in a given
period:
Budget deficit  G  T
• If G exceeds T, the government must
borrow from the public to finance the deficit.
It does so by selling Treasury bonds and
bills. In this case, a part of household
saving (S) goes to the government.
The Economy’s Influence on the
Government Budget
• Tax revenues depend on the state of
the economy.
• Some government expenditures
depend on the state of the economy.
• Automatic stabilizers are revenue
and expenditure items in the federal
budget that automatically change
with the state of the economy in such
a way as to stabilize GDP.
The Economy’s Influence on the
Government Budget
• The full-employment budget is a
benchmark for evaluating fiscal
policy.
• The full-employment budget is what
the federal budget would be if the
economy were producing at a fullemployment level of output.
The Economy’s Influence on the
Government Budget
• The cyclical deficit is the
deficit that occurs because of
a downturn in the business
cycle.
• The structural deficit is the
deficit that remains at full
employment.