Session 11 Fiscal Policy

1. 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.

2. 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.

3. Teaching the Terms

4. Fiscal Policy • Government spends money to provide goods and services • Government pays for those expenditures through taxation and borrowing

5. Externalities • Benefits or costs from a transaction extend beyond the buyer or seller • Positive externalities • Education • Technology spillovers or patent protection • Negative externalities • Pollution

6. Potential Market Failures

7. 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

9. 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

10. Federal Government: Receipts • Individual income taxes • Social insurance taxes • Corporate income taxes • Other

11. Federal Government: Spending • Social Security • National defense • Income security • Medicare • Health • Net interest • Other

12. Federal Government Revenue Source: Final Monthly Treasury Statement for FY2009

13. Federal Government Funding Source: Final Monthly Treasury Statement for FY2009

14. 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 Source: Final Monthly Treasury Statement for FY2009

15. State Government Revenue http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf

16. Texas Revenue Insurance trust includes unemployment, retirement and workers comp funds

17. State Government Expenditures http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf

18. Texas Expenditures

19. Local Governments Revenue http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf

20. Local Government Expenditures http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf

21. Structure of Taxes

22. Structure of Taxes

23. Budget Lingo

24. 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

25. 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

26. What is the Goal?

27. Business Cycle Long Run Growth Trend Real GDP Expansion Recession Time

28. Price Level Aggregate Supply PL1 Aggregate Demand Real GDP YF Full Employment Level of Output

29. 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)

30. Fiscal Responses to 2008 Recession

31. 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

32. 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

33. 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

34. 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

35. 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

36. 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”

37. 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

38. 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

39. Questions?