Session 11Fiscal 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

Rival in Consumption?

Yes No

Excludable?

Yes Private Goods Natural Monopolies

No Common Resources Public Goods

Potential Market Failures

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

Rival in Consumption?Yes No

Excludable

?

Yes

Private Goods• Clothing• Congested non-toll

roads• Ice cream

Natural Monopolies• Fire protection• Cable TV• Uncongested toll

roads

No

Common Resources• Fish in the ocean• Environment• Congested toll

roads

Public Goods• Tornado siren• National defense• Uncongested non-

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

Individual income taxes43%

Corporation income taxes7%

Social insur-ance and

retirement receipts

42%

Excise taxes3%

Estate and gift taxes1%

Customs duties1%

Federal Reserve deposits of earnings2%

Other miscellaneous receipts1%

Source: Final Monthly Treasury Statement for FY2009

Federal Government Funding

Deficit40%

Individual income taxes26%

Social insurance and retirement

receipts25%

Corporation income taxes4%

Other taxes and receipts5%

Source: Final Monthly Treasury Statement for FY2009

Federal Government Expenditures

Health and Human Services

21%

Social Security Administration

19%

Defense-Military17%

Interest on the public debt10%

Treasury8%

Labor4%

Agriculture3%

Veterans Affairs3%

Other15%

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

Source: Final Monthly Treasury Statement for FY2009

State Government Revenue

Borrowing 7%

Sales taxes and gross receipts

18%

Licenses2%

Individual income taxes13%

Corporate income taxes2%

Property taxes1%

Other taxes1%Charges and miscellaneous

13%

From federal government

21%

From local governments 1%

Utility revenue 1%

Insurance trust revenue

19%

http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf

Texas Revenue

Federal Gov-ern-

ment24% Local governments

1%

Sales taxes28%

Motor vehicle license 1%

Other taxes 6%

Higher education 5%

Hospitals 3%

Highways 0%

Interest earnings3%

Other general revenue 7%

Insurance trust revenue

23%

Insurance trust includes unemployment, retirement

and workers comp funds

State Government Expenditures

Education31%

Public welfare

24%

Health 3%

Hospitals 3%

Highways6%

Police protection 1%

Corrections3%

Natural resources 1%

Housing and community de-velopment

1%

Other 13%

Utility expenditure 2%

Insurance trust expenditure11%

http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf

Texas Expenditures

Social services and income

maintenance34%

Higher edu-cation17%

Elementary & secondary0%

Other education2%

Libraries0%

Insurance trust expenditure13%

Capital outlay11%

Highways10%

Public safety5%

Other and unallocable3%

Governmental administration2%

Environment and housing1%

Interest on general debt1%

Local Governments Revenue

Property taxes44%

Sales taxes and gross receipts 10%

Individual income taxes3%

Corporate income taxes1%

Other taxes4%

Education charges3%

Hospital charges7%

Sewerage4%

Interest earnings4%

Special assessment1%

Utility revenue 14%

Insurance trust revenue7%

http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf

Local Government Expenditures

Education39%

Public welfare 3%

Health 3%Hospitals

5%Highways

4%

Police protection 5%

Corrections2%

Sewerage3%

Solid Waste1%

Parks and Recreation2%

Housing and community development

3%

Administration5%

Interest4%

Other9%

Utility expenditures11%

Insurance trust expenditure2%

http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf

Structure of Taxes

• % of income paid in taxes ↓ as income ↑

Regressive

• % of income paid in taxes ↑ as income ↑

Progressive

• % of income paid in taxes is fixed as income changes

Proportional

Structure of Taxes

• Sales tax, Social Security taxes

Regressive

• U.S. federal income tax, estate taxes

Progressive

• Flat tax, Medicare tax

Proportional

Budget Lingo

• Revenues = Expenditures

Balanced budget

• Revenues < Expenditures

Budget deficit

• Revenues > Expenditures

Budget surplus

• Sum of all deficits – Sum of all surpluses

Government debt

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

• Capital gains • Tariffs

Deductions

• Mortgage interest

• Student loan interest

• Charitable donations

Spending

• Social Security

• NASA• Food stamps• Defense

Spending

Business CycleReal GDP

Time

Long Run Growth Trend

Recession

Expansion

Price Level

Real GDPYFFull Employment Level of Output

Aggregate Supply

PL1

Aggregate Demand

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 2009Renewable energy

and weatheriz

e 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?