Aaliyah Willis Lauren Potter Travis Bates Taylor Williams Ashlee Coleman Karen Castro
Built- In- Stability




Government tax revenues change automatically over course of business cycle
Constitutes nondiscretionary budgetary policy and results from the makeup of most tax
systems
Any net tax will yield more revenue as GDP rises
o As GDP rises & more goods are purchased, the revenue created increases
o Revenues from payroll taxes rise as the economy grows (more jobs created)
Transfer payments are opposite
o Unemployment compensation, welfare payments & subsidies all decrease during
economic growth
Automatic or Built- In Stabilizers





Built-in Stabilizers: anything that increases the government’s budget deficit (or reduces
its budget surplus) during a recession & increases its budget surplus (or reduces budget
deficit) during inflation without requiring explicit action by policymakers.
Gov’t is assumed to be independent of the level of GDP
Congress decides on a particular level of spending, but it doesn’t determine the
magnitude of tax revenues
Congress establishes tax rates
Tax revenues then vary directly with the level of GDP that the economy achieves
o For graph example look at page 229
Economic Importance



When taxes rise, aggregate demand decreases
o This allows control of inflation/slumping, as it directly influences DI
Tax revenues automatically rise when GDP rises and vice versa
In addition as GDP rises with taxes, it creates a surplus, while when GDP & taxes
decreases, the surplus falls and moves toward deficit
Tax Progressivity

Automatic budget deficits or surplus (and thus, built-in stability) depends on the
responsiveness of tax revenues to changes in GDP.
o If tax revenues change sharply as GDP changes, the slope of line T will be steep
and the vertical distances between T and G will be large
o If tax revenues change very little as GDP changes, the slope will be gentle and
built-in stability will be low







Referring to Figure 12.4 on pg. 231
Progressive Tax System- the average tax rate remains constant as GDP rises
Regressive Tax System- the average tax rate falls as GDP rises
The progressive tax system has the steepest tax line T of the three. However, the tax
revenues will rise with GDP under both the progressive and the proportional tax systems,
and they may rise, fall, or stay the same under a regressive tax system.
Main Point: The more progressive the tax system, the greater the economy’s built in
stability
Deficit- Surplus Swing
o 1993 Clinton increased highest marginal tax on PI from 3% to 39.6% and
corporate income tax to 35%
 This raised overall progressivity in the tax system, and helped the built-in
stability
Built-in stability decreases severity of business fluctuations and diminishes swings in
GDP
Evaluating Fiscal policy
Group 2: pg 230-232 – 4th period



Adjust deficits and surpluses to eliminate automatic changes in tax revenues.
Compare sizes of the adjusted budget deficits or surpluses to level of GDP.
Full employment budget
- Also known as standardized budget
- Measures what the Fed budget deficit/surplus would be with existing tax rates and
government spending levels if there was full employment.
- Remove budget deficit or surplus that is caused simply by changes in GDP.
 Cyclical deficit
- A byproduct of the economy’s slide into a recession, not the result of discretionary
fiscal actions by the government
 Full employment deficits are usually smaller than actual deficits
- This is because actual deficits include cyclical deficits, where full employment
deficits don’t.
- As there is a full employment surplus, there is an actual surplus
 From the 1990’s we have changed from expansionary to contractionary fiscal policy.
- The reasoning for this change is claimed to have helped to rapidly grow the U.S.
economy while maintaining full employment.
- The downside is that aggregate demand went down and the price level was
unstable.
Group 3: Taylor, Vanessa, Chris J., Chris I., Tommy, Michael, Mason, Josh, Jared, Denton
Problems, Criticisms, and Complications

Problems of timing
o Recognition lag- the time between the onset of the recession and the awareness that
the recession is occurring.
o Forecasting tools can help indicate the economy’s projection, but it can still take 4-6
months for the data to make a difference.
 Administrative lag
o Because the government operates slowly, there is also a delay between the time the
need arises and the time that the government takes action.
 Operational lag
o Lag also occurs between the times that fiscal action is taken to the time that such action
has any effects. Tax rates take effect (relatively) quickly, but G takes time to take effect.
o Such spending doesn’t decrease too much in a slant recession.
Crowding out

After expansionary spending, the government will use borrowed money from the market to
cover the deficit, thus raising interest rates and decreasing Ig.
Fiscal Policy, Aggregate Supply, and Inflation



Aggregate supply can complicate fiscal policy
No crowding out effect and expansionary fiscal policy shorts the AD curve from AD to AD2.
If the AS curve were horizontal the area level, would remain at the existing price level, and the
economy would achieve full employment.
 But when AS curve slopes upward, part if the increase in AD is dissipated in higher prices.
 Fiscal policy faces the realities imposed by upward-sloping portion of the AS curve.
 May cause inflation and unemployment, and an increase in GDPr.
Fiscal Policy in the Open-Economy
 Complications arise from the fact that each economy is a component of the world economy.
Shocks Originating from Abroad


Nation’s economy affected by Xn
Unforeseen international AD shocks can alter GDP making current fiscal policy inappropriate
o Ex. US is in a recession and enacted a fiscal policy to expand economy. Foreign nations
experience increased wealth and begin to buy US goods. The increased Xn causing the
US to experience demand-pull inflation. Had the policy makers known Xn might rise, a
loss expansionary policy would have been enacted.
 Participation in world economy may:
o Bring with mutual inter dependence
o Makegains derived from specialization and trade
Net export effect



Works with trade to reduce the effectiveness of fiscal policy
A higher interest rate will attract capital, interest won’t change.
When demand for a commodity increases causing its price to rise, causing the price of the dollar
to rise in terms of foreign currencies.
 Because more units of foreign currencies are needed to buy us goods, US exports decline.
 Americans then buy more imports because the US dollar is worth more foreign currency units.
 Net export expenditures diminish and the expansionary fiscal policy of the US will be partially
negated.
Supply-Side Fiscal Policy
o
o
o
o
o
Direct link between fiscal policy and aggregate supply is the supply-side fiscal-policy.
o i.e., Tax changes.
Aggregate supply is an upward clopping curve without distinct segments.
A rightward shift of the curve increases real GDP, caused by tax reduction.
3 reasons for a rightward shift:
1. Saving and investment- lowers taxes mean more disposable income and an increase in
household savings, thus increasing nations stock of capital.
2. Work incentives- decrease income tax rates and means a rise in after-tax wages, thus
encouraging work.
3. Risk taking- a lower tax rate encourages risk taking, thus making businesses more willing
to risk capital on new production methods and new products if they are almost
guaranteed a larger potential after-tax reward.
Skeptical economists doubt the effectiveness of the supply-side tax-cuts.
o They doubt positive effects of tax reduction incentives.
o They think any rightward shifts of the AS curve would occur only over an extended
period of time, whereas the demand side would be impacted quicker, and therefore
inflationary.