Fiscal Policy
© 2009, TESCCC
1
Fiscal Policy defined
The government’s
(Congress and the President)
use of taxing and spending to promote
economic growth and stability
© 2009, TESCCC
2
History of Fiscal Policy
Laissez-faire (classical
economics)
The Great Depression
1929-1930s
WWII
1939-1945
•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.
© 2009, TESCCC
3
History of Fiscal Policy
1960s
1980s
•JFK proposed tax cuts to
personal and business
income taxes to increase
aggregate demand.
•Government spending
increased due to 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.
© 2009, TESCCC
4
Two branches of Fiscal
Policy:
1. Demand side
2. Supply side
© 2009, TESCCC
5
Demand-Side Economics
Inspired by John Maynard Keynes
during the Great Depression and is
also called Keynesian Fiscal Policy
© 2009, TESCCC
Looks at changing aggregate demand
which is either increasing or
decreasing
6
Tools of Fiscal Policy
1. Taxing Policy of Government
2. Spending Policy of Government
© 2009, TESCCC
7
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.
© 2009, TESCCC
8
Limitations of Demand-Side
Fiscal Policy
1.
Not coordinated with monetary policy
2.
Surplus budget unpopular and politicians lack the
political will to carry it out
3.
Time lags - Inside lags and outside lags
4.
People are unpredictable - Economics is a social
science so we are dealing with human behavior.
5.
Doesn’t solve stagflation
© 2009, TESCCC
9
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.
© 2009, TESCCC
10
Fiscal Policy- Supply Side
© 2009, TESCCC
11
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).
© 2009, TESCCC
12
Principles of Supply Side
1. Tax cuts - encourage consumers to save
so businesses have money to borrow for
capital investment.
2. Government spending cuts especially on
transfer payments where nothing is
produced
3. Deregulate business
Overall Less Government
© 2009, TESCCC
13
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.
© 2009, TESCCC
14
Laffer Curve
100%
Govt will collect no
revenue at 2 tax
rates, 0% and 100%.
T
a
x
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
R
a
t
e
s
0%
Tax Revenues
© 2009, TESCCC
15
Laffer Curve
100%
T
a
x
R
a
t
e
s
C
Point C is the
optimum tax rate.
Higher tax rates
decrease worker
incentives.
Below C we decrease
the revenue.
0%
Tax Revenues
© 2009, TESCCC
PROBLEM: We don’t
know where we are on
the curve.
16
Limitations
1. Lack of experience- hasn’t been around
long enough.
2. Don’t know where we are on Laffer
Curve.
3. Makes Federal Income Tax less
progressive and reduces the automatic
stabilization and reduces many “safety
net” programs.
© 2009, TESCCC
17
Taxing & Spending
DECIDING FISCAL POLICY
© 2009, TESCCC
18
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.
© 2009, TESCCC
19
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
© 2009, TESCCC
20
Purposes of Taxation
•Raise revenue
•Regulate the economy (fiscal policy)
•Redistribution of income (transfer
payments)
•Provide positive economic incentives
•Provide negative economic incentives
© 2009, TESCCC
21
Types of Taxes or Tax Structures
•Progressive - takes larger percent of
income from higher income groupsas income goes up tax rate increases
•example- Federal Income Tax
© 2009, TESCCC
22
Types - Regressive
• Regressive- takes larger percent of
income from the lower income group
• Example- sales tax, property tax, Social
Security tax
© 2009, TESCCC
23
Types - Proportional
•Proportional - takes the same per cent
of income from all income levels
•Examples - some state income taxes &
proposed flat tax
© 2009, TESCCC
24
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.
© 2009, TESCCC
25
Principles of Taxation
1.
© 2009, TESCCC
Benefits received- people who
directly benefit or use the good
or service should pay
• Example- Excise tax on
gasoline used to build roads
26
2. Ability- to- pay- people who
have more wealth or income
should pay more.
• Example- Federal Income Tax
© 2009, TESCCC
27
Top Federal Taxes
• Individual Income Tax
• Social Security
• Corporate Income Tax
© 2009, TESCCC
28
Federal Taxes
Ind. Income Tax
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
© 2009, TESCCC
Corp. Income
Tax
Social Security
Excise Taxes
Estate & gift
Customs
Other
29
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.
© 2009, TESCCC
30
State Taxes
• States receive most of their revenue from
a Sales Tax.
© 2009, TESCCC
31
Local Taxes
• Property Tax
© 2009, TESCCC
32