CH 15 Fiscal Policy

1. CH 15 Fiscal Policy

2. Introduction: • As the American economy slid into recession in 1929, economists relied on the Classical Theory of economics, which promised that the economy would self-correct if government did not interfere. • But as the recession deepened into the Great Depression and no correction occurred, economists realized that a revision in theory would be necessary. John Maynard Keynes developed Keynesian Theory, which called for government intervention to correct economic instability. • Question: Scope of government especially in the area of taxing, spending and borrowing. In this world nothing can be said to be certain except death and taxes. Benjamin Franklin Government’s view of the economy can be summed up in a few short phrases; if it moves, tax it. If it keeps moving, regulate it. If it stops moving, subsidize it. Ronald Reagan

3. In whom do we trust? • Democrats, Republicans • US Government • God • Psalms 118:8-9- It is better to trust the Lord than to put confidence in man. It is better to trust the Lord than to put confidence in princes. • Cracked cistern vs. living water

4. 15A Objectives • Define Fiscal policy: • Actions of the government taken to affect total output (GDP) AND employment through the three tools of; spending, taxing and borrowing

5. 15A Objective • Goal of Fiscal Policy: to keep the business cycles in check Ability to purchase G&S outstrips production.

6. 15A Objectives • Keynesian Economic Solution: draw chart pg. 303

7. 15A Objectives • First tool: Gov’t spending- a reflection of national priorities • National Budget: money in (revenue) & money out (expenditures, or spending) • Just like a family Budget: some of the Spending is fixed- called mandatory spending and the other is adjustable, called discretionary spending.

8. 15A Objectives • Marginal Propensity to consume- AKA Expenditure Multiplier • David has $1: spends 85 cents and saves 15 cents • Spent portion called MPC- marginal propensity to consume • Saved portion called MPS- marginal propensity to save • Expenditure formula: Amount Received x 1/(1-MPC) • See pg. 306 • You try: $200 is added to the economy with a MPC of 90 • $200 x 1/(1-90)= $200 x 1/.10 • $200 x 10 • $2000 income added to the nation

9. 15 A Objectives • Formula: amount rec. x 1/(1-MPC) • Given $1,000,000 at MPC of 85 • $1,000,000 x 1/.15 • $1,000,000 x 15 • Equals $15,000,000

10. 15 A Objectives • 4 Problems with spending as a fiscal tool • 1. time lags: caused by debate, political concerns and compromise render many decisions useless as the original data has changed by the time a solution is reached. • 2. Uncertain multiplier: hard to gauge or predict with accuracy • 3. Politics: political incentives for re-election and popular politics call for increased spending and lower taxes. A promise hard to deliver in cycles of inflation/recession. • 4. Sources of Additional Spending: the gov’t can spend money, create jobs and expand the economy but it has a cost, a trade off. From where will it get the money? Who is effected?

11. 15B Objectives • Second Policy tool: taxation • Tim Hawkins video: Government Can • History of taxation: “nothing is certain but death and taxes” • No taxation w/o representation • Weakness of the Articles of Confederation • Constitution: revenue from land sales, tariffs & excise taxes • 16th Amendment: Passed by Congress on July 2, 1909, and ratified February 3, 1913, the 16th amendment established Congress's right to impose a Federal income tax.

12. 15 B Objectives • Sources of tax revenue (money in to federal budget) • 1. FICA- Federal Insurance Contribution Act- social security insurance tax paid by employee and employer • 2. Corporate taxes: paid from firm’s profits after company expenses deducted • 3. Excise tax: certain targeted consumer goods like gasoline, alcoholic drinks and cigarettes • 4. Personal Income tax: based on income level. US adopted a progressive tax system. • See handout to study three types of taxes and complete worksheets. • Activity using the Laffer Curve

14. 15B Objectives Problems with taxation as a fiscal policy tool • Effect on national work ethic: progressive tax a potential disincentive to work harder and produce more • Confusion in the marketplace: to encourage MPC gov’t discourages investment in capital assets through taxes (stocks, bonds, capital gain taxes etc.) which means more consumer spending and less capital savings for business loans and expansion.

15. 15C Objectives • Keynesian Economic theory further stated that the gov’t could borrow money and spend it to boost the economy to prosperity. • Then raise taxes and use revenue to pay off debt from borrowing or save for a rainy day.

16. 15C Objectives Problem with borrowing as a tool of fiscal policy • No reserve bucket: gov’t borrowing means crowding out for industry • Addictive: borrowing exceeds debt reduction especially for politicians seeking re-election. • Destroys Future Productivity: often short-term solutions for immediate gain at the expense of future calamity

17. Simulation Activity • INTRODUCTION • The new President of the United States has been elected on the promise of fiscal responsibility. He has promised the voters he will not raise taxes, and he will not reduce Social Security or Medicare. He has promised interest groups that he will not reduce Commerce Department spending. By law he cannot reduce the net interest paid on the debt. The President's budget is projected to leave the country with a $230 billion surplus, and he promises not to allow a deficit, unless the U.S. faces a recession or war.

18. Simulation Activity pg. 2 • Suddenly, the United States is subject to military attack -- a turn of events not anticipated in the current budget. At the same time, a lingering recession reduces the government's tax revenues and forces the government to increase its spending on unemployment benefits, welfare, housing assistance, food stamps, and other need-based programs. Because of the increased spending and reduced revenues, the nation falls into a projected deficit of nearly $429 billion. • Then Congress passes legislation to increase military spending by 20 percent, to pay for increased security within the U.S. and to pay for a prolonged military response against the attacking country and other potential threats. The President signs this bill into law, increasing the projected deficit to nearly $530 billion.

19. Simulation Activity pg. 3 • The President is committed to keeping his campaign promises, in order to maintain support for his reelection. He should but does not have to protect the programs he promised to protect, and he cannot raise taxes, so he must cut spending on other programs to stay within his new guideline to keep the deficit below $450 billion. The President turns to you, his trusted economic advisor, for help. • Your suggestions: What should be cut? Eliminate or reduce wasteful spending and unnecessary programs. Eliminate or reduce needed programs according to how you see fit. • http://www.econedlink.org/national-budget-simulator.php • Did you increase or decrease the budget deficit? What programs did you cut? Liberal or Conservative programs? Domestic or Foreign Policy programs?