Session 11
Fiscal Policy
Disclaimer: The views expressed are those of the presenters and do not necessarily reflect those
of the Federal Reserve Bank of Dallas or the Federal Reserve System.
TEKS
(15) Economics. The student understands the economic impact of
fiscal policy decisions at the local, state, and national levels. The
student is expected to:
(A) identify types of taxes at the local, state, and national levels and
the economic importance of each;
(B) analyze the categories of revenues and expenditures in the U.S.
federal budget; and
(C) analyze the impact of fiscal policy decisions on the economy.
(6) Economics. The student understands the basic characteristics and
benefits of a free enterprise system. The student is expected to:
(D) analyze the costs and benefits of U.S. economic policies related
to the economic goals of economic growth, stability, full
employment, freedom, security, equity (equal opportunity versus
equal outcome), and efficiency.
Teaching the Terms
Fiscal Policy
• Government spends money to provide goods
and services
• Government pays for those expenditures
through taxation and borrowing
Externalities
• Benefits or costs from a transaction extend
beyond the buyer or seller
• Positive externalities
– Education
– Technology spillovers or patent protection
• Negative externalities
– Pollution
Potential Market Failures
Excludable?
Rival in Consumption?
Yes
No
Yes
Private Goods
Natural Monopolies
No
Common Resources
Public Goods
Catagorize
•
•
•
•
•
•
Cable TV
Clothing
Congested non-toll roads
Congested toll roads
Environment
Fire protection
•
•
•
•
•
•
Fish in the ocean
Ice cream
National defense
Tornado siren
Uncongested non-toll roads
Uncongested toll roads
Excludable?
Yes
No
Rival in Consumption?
Yes
No
Private Goods
Natural Monopolies
• Clothing
• Fire protection
• Congested non-toll • Cable TV
roads
• Uncongested toll
• Ice cream
roads
Common Resources
Public Goods
• Fish in the ocean
• Tornado siren
• Environment
• National defense
• Congested toll
• Uncongested nonroads
toll roads
Potential for Market Failure
• Public goods are subject to a free-rider
problem
– Lighthouse, basic research
• Common resources can lead to the tragedy of
the commons
– Clean air and water, congested cities
• Role of property rights
Federal Government: Receipts
•
•
•
•
Individual income taxes
Social insurance taxes
Corporate income taxes
Other
Federal Government: Spending
•
•
•
•
•
•
•
Social Security
National defense
Income security
Medicare
Health
Net interest
Other
Federal Government Revenue
Estate and gift taxes
1%
Excise taxes
3%
Customs duties
1%
Social
insurance
and
retirement
receipts
42%
Source: Final Monthly Treasury Statement for FY2009
Other miscellaneous Federal Reserve deposits
receipts
of earnings
1%
2%
Individual
income
taxes
43%
Corporation income taxes
7%
Federal Government Funding
Other taxes and receipts
5%
Corporation income taxes
4%
Social insurance
and retirement
receipts
25%
Individual
income taxes
26%
Source: Final Monthly Treasury Statement for FY2009
Deficit
40%
Federal Government Expenditures
Note: “Other” includes many agencies, such as
Transportation, Housing and Urban Development,
Education, Homeland Security, Justice, Energy,
State, NASA, International Assistance Programs,
Interior, Commerce, EPA and Corps of Engineers
Veterans Affairs
3%
Other
15%
Agriculture
3%
Health and
Human
Services
21%
Labor
4%
Social Security
Administration
19%
Treasury
8%
Interest on the
public debt
10%
Source: Final Monthly Treasury Statement for FY2009
DefenseMilitary
17%
State Government Revenue
Borrowing
7%
Utility revenue
1%
From local governments
1%
Insurance trust
revenue
19%
Licenses
2%
From federal
government
21%
Charges and
miscellaneous
13%
Sales taxes and
gross receipts
18%
Individual
income taxes
13%
Other taxes
1%
http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
Property
taxes Corporate income taxes
1%
3%
Texas Revenue
Insurance trust includes
unemployment, retirement
and workers comp funds
Insurance
Federal
trust
Governmen
revenue
t
23%
24%
Other general revenue
7%
Interest earnings
3%
Highways
0%
Hospitals
2%
Higher
education
5%
Other taxes
6%
Motor vehicle license
1%
Sales
taxes
28%
Local governments
1%
State Government Expenditures
Utility expenditure
2%
Insurance trust
expenditure
11%
Education
31%
Other
13%
Housing and
community
development
Natural resources
1%
1%
Police protection
Corrections
1%
3%
Highways
6%
Hospitals
3% Health
Public
welfare
25%
3%
http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
Texas Expenditures
Governmental administration
2%
Other and unallocable
3%
Environmen Interest on general debt
t and
1%
housing
1%
Public safety
6%
Social services
and income
maintenance
34%
Highways
10%
Capital outlay
11%
Insurance trust expenditure
13%
Higher
education
17%
Libraries
0% Other education
2%
Elementary & secondary
0%
Local Governments Revenue
Insurance trust revenue
7%
Special assessment
1%
Utility
revenue
14%
Interest earnings
4%
Sewerage
4%
Hospital
charges
6%
Property
taxes
44%
Education charges
3%
Corporate
Other taxes income taxes Individual income taxes
1%
3%
3%
http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
Sales taxes and
gross receipts
10%
Local Government Expenditures
Insurance trust
expenditure
2%
Utility
expenditures
11%
Other
9%
Interest
4%
Administration
5%
Education
39%
Housing and community
development
3%
Parks and Recreation
2%
Sewerage
Solid Waste
3%
Public welfare
1%
Police
3%
Health
Corrections
protection Highways Hospitals 3%
2%
5%
4%
5%
http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
Structure of Taxes
Regressive
• % of income paid in taxes ↓ as income ↑
Progressive
• % of income paid in taxes ↑ as income ↑
Proportional
• % of income paid in taxes is fixed as income changes
Structure of Taxes
Regressive
• Sales tax, Social Security taxes
Progressive
• U.S. federal income tax, estate taxes
Proportional
• Flat tax, Medicare tax
Budget Lingo
Balanced budget
• Revenues = Expenditures
Budget deficit
• Revenues < Expenditures
Budget surplus
• Revenues > Expenditures
Government debt
• Sum of all deficits – Sum of all surpluses
Deficits and Debt
• Government must borrow money when it runs
a budget deficit
• Government borrows from
– Individuals
– Corporations
– Financial institutions
– Foreign entities or foreign governments
Fiscal Policy and Economic Goals
• National economic goals include
–
–
–
–
–
–
–
Growth
Stability
Full employment
Freedom
Security
Equity
Efficiency
• Using government spending and taxation
programs to achieve goals
What is the Goal?
Taxes
Deductions
Spending
• Capital gains
• Tariffs
• Mortgage
interest
• Student loan
interest
• Charitable
donations
• Social
Security
• NASA
• Food stamps
• Defense
Spending
Business Cycle
Long Run Growth
Trend
Real
GDP
Expansion
Recession
Time
Price Level
Aggregate Supply
PL1
Aggregate Demand
YF
Full Employment
Level of Output
Real GDP
Expansionary Fiscal Policy
• Response to a recession (economy is
operating below full employment)
• Seeks to stimulate production (and
consumption)
– Directly (expenditures ↑)
– Indirectly (taxes ↓ to encourage household
spending or investment spending)
Fiscal Responses to 2008 Recession
Emergency
Economic
Stabilization
Act of 2008
Established
the Troubled
Assets Relief
Program
(TARP)
American Recovery and Reinvestment Act of 2009
Renewable
energy and
weatherize
buildings
New
infrastructure
(roads,
bridges, and
mass transit)
Fund Pell
Grants
Making Work
Pay tax credit
and Child Tax
Credit
Contractionary fiscal policy
• Response to inflation (economy is operating
above full employment and prices are rising)
• Seeks to reduce production (and
consumption)
– Directly (expenditures ↓)
– Indirectly (taxes ↑ to discourage household or
investment spending)
• Politically difficult
Measuring Fiscal Policy’s Effects
• Effects are not limited to the initial dollar
value of the change in policy
• The eventual effects may be larger or smaller,
depending on:
– Multiplier effect
– Crowding-out effect
Multiplier Effect
• Spending and tax policies create a chain
reaction in the economy as people spend new
income
• Many factors complicate the multiplier
– Taxes
– International trade
– Differing consumption patterns among various
segments of the population
Crowding Out
• Investment or consumption spending that is
lost because government borrowing drives up
interest rates
• Government is entering the same market for
funds as investors
Two Types of Fiscal Policy
• Discretionary fiscal policy
– Policymakers change tax policies or spending
programs in response to fluctuations in the
business cycle (at their discretion)
• Automatic stabilizers
– Implemented without any deliberate action from
policymakers
– Found in the tax system and spending programs
Automatic Stabilizers – Tax System
• Taxes are linked to economic activity
– Progressive income tax rates (individual and
corporate)
– Payroll taxes
– Sales and excise taxes
• Recessions → automatic “tax cut”
• Expansion → automatic “tax increase”
Automatic Stabilizers – Spending
• Government spending responds to the
business cycle
– Unemployment insurance benefits
– Welfare benefits
– School lunch programs
– Other income-support programs
• Recessions → more spending
• Expansion → less spending
Challenges Related to Fiscal Policy
• Political factors
• Time lags
– Time required to create and pass legislation
– Time required to implement legislation
• Supply side impacts
• Forecasting difficulties
• Monetary policies may reinforce or offset
fiscal policies
Questions?