Fiscal Policy: Fiscal Policy: Fixing an Economy’s Fixing an Economy’s

HealthHealth

What is What is Fiscal PolicyFiscal Policy??

The use of The use of Government Government policies in policies in order to order to

stabilize the stabilize the Business Business

Cycle.Cycle.

Points to RememberPoints to Remember

Prior to the Prior to the Great Depression Great Depression (1930’s)(1930’s) economists believed that economists believed that the best way to stabilize the the best way to stabilize the economy was through the natural economy was through the natural market forces/ market forces/ Adam SmithAdam Smith

After the After the DepressionDepression: : The gov’t The gov’t stepped in (FDR) to help. This action stepped in (FDR) to help. This action ((Fiscal Policy) Fiscal Policy) is an example of is an example of ((John) Keynesian Economics.John) Keynesian Economics.

Policy Theory in Our Govt.Policy Theory in Our Govt.

Republican/ Conservative General Republican/ Conservative General Theory:Theory:– Small governmentSmall government– Generally Low taxesGenerally Low taxes– Individual responsibilityIndividual responsibility– Less govt. control & regulationsLess govt. control & regulations

Democrat/ Liberal General Ideas:Democrat/ Liberal General Ideas:– Progressive taxes/ make more you pay moreProgressive taxes/ make more you pay more– Social programs/ community responsibilitySocial programs/ community responsibility– Govt. regulationGovt. regulation– Larger govt. to support peopleLarger govt. to support people

Important Concepts:Important Concepts:

GDP: GDP: Gross domestic product Gross domestic product is the is the aggregateaggregate (total) (total) market value market value of all final goods and services of all final goods and services produced within a country in a given period of produced within a country in a given period of time.time.– Sometimes the measurement is looked at on a Sometimes the measurement is looked at on a per per

person scaleperson scale, which is known as…, which is known as…REAL GDP.REAL GDP.

Inflation: Inflation: is a sustained increase in the is a sustained increase in the average price level of goods and services.average price level of goods and services.

Stagflation: Stagflation: A period of inflation combined A period of inflation combined with high unemployment (with high unemployment (a recession or a recession or depression)depression)

The 3 “tools” of Fiscal Policy: The 3 “tools” of Fiscal Policy: 1.1. Government Purchases & Government Purchases &

SpendingSpending

2. Entitlement Programs 2. Entitlement Programs (also called (also called Transfer Payments)Transfer Payments)

3. Taxes3. Taxes……these three tools impact macroeconomic these three tools impact macroeconomic variables such as real GDP, employment, variables such as real GDP, employment,

price level, and economic growth.price level, and economic growth.

G.E.T.G.E.T.

MultiplierMultiplier EffectEffect For every dollar spent by For every dollar spent by

the federal government, the federal government, GDP will GDP will increase by more increase by more than that $1 than that $1

It takes money to make It takes money to make money!money!

$20$2000

Multiplier Effect:Multiplier Effect: each dollar spent will tend to each dollar spent will tend to generate more than 1 dollar added to GDP.generate more than 1 dollar added to GDP.

How just a little Fiscal Policy can How just a little Fiscal Policy can effect our economy in a BIG way.effect our economy in a BIG way.

$15$1500

$15$1500

$50 (already $50 (already in his pocket)in his pocket)

$200 already $200 already in his pocket)in his pocket)

$40$4000

Fiscal Policy and TaxesFiscal Policy and Taxes

An An increaseincrease in tax rates = decreased in tax rates = decreased disposable income = consumption & disposable income = consumption & real GDP decreasereal GDP decrease

A A decreasedecrease in taxes = increases in taxes = increases disposable income = consumption & disposable income = consumption & real GDP increasereal GDP increase

What is disposable income??What is disposable income??

Fiscal Policy and TaxesFiscal Policy and Taxes

TaxesDisposable Income

Consumption & Real GDP

TaxesDisposable Income

Consumption & Real GDP

So which is better HIGHER or LOWER TAXES?

WHY?

When to use Fiscal Policy?When to use Fiscal Policy?

1.1. When the When the economy is in a economy is in a recession or recession or depressiondepression the the economy has economy has contracted.contracted.

The government The government will enact an will enact an Expansionary Expansionary Fiscal PolicyFiscal Policy to to help boost the help boost the economy.economy.

Expansionary Fiscal PolicyExpansionary Fiscal Policy

When to useWhen to use: (recession) : (recession) supply is supply is bigger than demand because people bigger than demand because people are not spending.are not spending.

What to doWhat to do: : – increase gov’t purchasesincrease gov’t purchases– decrease taxesdecrease taxes– increase entitlements (transfer increase entitlements (transfer

payments) to stimulate economy.payments) to stimulate economy.

Government Use of Fiscal PolicyGovernment Use of Fiscal Policy

2.2. When the economy When the economy is in is in anan economic economic boom/ peak boom/ peak the the economy has economy has expanded.expanded.

The government The government will enact an will enact an Contractionary Contractionary fiscal policyfiscal policy to to help slow down help slow down the economy.the economy.

Contractionary Fiscal PolicyContractionary Fiscal Policy

When to useWhen to use: (peak) : (peak) demand demand exceeds supply because people have exceeds supply because people have too much money.too much money.

What to doWhat to do: : – decrease gov’t purchasesdecrease gov’t purchases– increase taxesincrease taxes– decrease Entitlements (transfer decrease Entitlements (transfer

payments) to close expansion gap.payments) to close expansion gap.

Sum it up...Sum it up...

Economy is in Economy is in a recession or a recession or

depressiondepression

ExpansionarExpansionary Fiscal y Fiscal PolicyPolicy

Economy is in Economy is in a boom/peaka boom/peak

Contractionary Contractionary Fiscal PolicyFiscal Policy

Problems with Fiscal PolicyProblems with Fiscal Policy Doesn’t work during periods of Doesn’t work during periods of

stagflationstagflation- can’t fight - can’t fight unemployment and inflation at the unemployment and inflation at the same timesame time

Entitlements or transfer paymentsEntitlements or transfer payments: : – It is difficult to estimate the natural rate It is difficult to estimate the natural rate

of unemployment- of unemployment- people lie!people lie! The The time lagstime lags involved in involved in

implementing fiscal policy implementing fiscal policy (takes the (takes the government a long time to do anything).government a long time to do anything).

AND…..AND…..

More Problems with Fiscal More Problems with Fiscal PolicyPolicy

Economists and policy makers question the Economists and policy makers question the effectiveness of fiscal policy because of effectiveness of fiscal policy because of deficits.deficits.

The government experiences a budget The government experiences a budget deficit during deficit during expansionary fiscal expansionary fiscal policypolicy..

GOV. GOV. SPENDINGSPENDING

++BUDGET BUDGET DEFICITDEFICIT

(negative)(negative)

==TAXESTAXES(Revenue (Revenue for Gov.)for Gov.)

Fiscal Policy’s Fiscal Policy’s Effects on LaborEffects on Labor

Fiscal Policy’s Effects on LaborFiscal Policy’s Effects on Labor

If the government does anything to If the government does anything to pump money into the economy, pump money into the economy, then then the labor supply should increase along the labor supply should increase along with the number of jobs availablewith the number of jobs available..

However, the unemployed, who benefit However, the unemployed, who benefit from increased transfer payments from increased transfer payments (Expansionary Fiscal Policy),(Expansionary Fiscal Policy), may have may have lessless incentive to find work. incentive to find work.

Fiscal Policy’s Effects on LaborFiscal Policy’s Effects on Labor

Inversely, during Inversely, during Contractionary Fiscal Policy,Contractionary Fiscal Policy, workers who find their wage reduced by the workers who find their wage reduced by the higher tax rates higher tax rates may be less willing to work.may be less willing to work.

The supply of labor could The supply of labor could decreasedecrease as a result as a result ofof increased tax rates increased tax rates or or increasedincreased transfer transfer paymentspayments resulting in aggregate supply resulting in aggregate supply declining. declining.

Which will cause an economy’s GDP to Which will cause an economy’s GDP to declinedecline..

Simply, there is not enough workers so Simply, there is not enough workers so wages increase. wages increase.

Taxes: Who Taxes: Who Should Pay Less Should Pay Less

or More? or More?

1.) Progressive Income Tax Table1.) Progressive Income Tax Table

Single filers Married filing jointly Head of household Tax Rate

Up to $7,150 Up to $7,150 Up toUp to$14,300 $14,300 Up to $10,200 Up to $10,200 10%

$7,151 - $29,050 $7,151 - $29,050 $14,301 - $58,100 $14,301 - $58,100 $10,201 - $38,900 $10,201 - $38,900 15%

$29,051 - $70,350 $29,051 - $70,350 $58,101 - $117,250 $58,101 - $117,250 $38,901 - $100,500 $38,901 - $100,500 25%

$70,351 - $146,750 $117,251 - $178,650 $100,501 - $162,700 28%

$146,751 - $319,100 $146,751 - $319,100 $178,651 - $319,100 $178,651 - $319,100 $162,701 - $319,100 $162,701 - $319,100 33%

$319,101$319,101or more or more

$319,101$319,101or more or more

$319,101$319,101or more or more 35%

TWO THEORIES ON TWO THEORIES ON WHOWHO SHOULD SHOULD PAY TAXESPAY TAXES

1.1. Benefits-Received PrincipleBenefits-Received PrincipleOnly those who receive benefits should pay taxes.Only those who receive benefits should pay taxes.

EXAMPLE:EXAMPLE: City of Canton is building a new parkway to City of Canton is building a new parkway to limit the amount of traffic so a tax is raised to pay for it. limit the amount of traffic so a tax is raised to pay for it. ONLY those who use the parkway should pay (the citizen of ONLY those who use the parkway should pay (the citizen of Canton, NOT the citizens of Hickory Flat)Canton, NOT the citizens of Hickory Flat)EXAMPLE:EXAMPLE: Gasoline Sales Tax goes toward road Gasoline Sales Tax goes toward road construction (you ride on them, you pay for them)construction (you ride on them, you pay for them)

2.2. Ability-to-Pay PrincipleAbility-to-Pay PrincipleOnly those with the ability to pay should pay MORE of Only those with the ability to pay should pay MORE of

the tax.the tax.EXAMPLE:EXAMPLE: Same Canton situation, but those who pay Same Canton situation, but those who pay more of the tax should be the wealthy.more of the tax should be the wealthy.

TYPES OF TAXESTYPES OF TAXES

1. 1. Progressive Tax Progressive Tax (ex-income tax)(ex-income tax)Those who make more, pay moreThose who make more, pay more

22. . Regressive TaxRegressive TaxA regressive tax is a tax which takes a A regressive tax is a tax which takes a LARGER LARGER

PERCENTAGEPERCENTAGE of income from people whose income is LOW. of income from people whose income is LOW.Regressive taxes, as opposed to progressive taxes, are more Regressive taxes, as opposed to progressive taxes, are more

burdensomeburdensome on lower-income individualson lower-income individuals than on higher-income than on higher-income individualsindividuals. . (EXAMPLE: SALES TAX)(EXAMPLE: SALES TAX)

3. 3. Proportional TaxProportional Tax (EX: FAIR TAX (EX: FAIR TAX))A tax that charges the A tax that charges the same percentage same percentage of income, regardless of income, regardless

of the size of income.of the size of income.

2) 2) Progressive Income TaxProgressive Income Tax

INCOMEINCOME == GDP & AD/ GDP & AD/ consumption consumption ==INCOMEINCOME

TAXESTAXES

DURING A DURING A PEAK:PEAK:

INCOMEINCOME == ==INCOMEINCOMETAXESTAXES

DURING A DURING A RECESSION:RECESSION:

How it works.How it works.

GDP & AD/ GDP & AD/ consumption consumption

TYPES OF TAXESTYPES OF TAXES2. 2. Regressive TaxRegressive Tax

A regressive tax is a tax which takes a A regressive tax is a tax which takes a LARGERLARGER PERCENTAGEPERCENTAGE of income from people whose income is LOW. of income from people whose income is LOW.

Social Security tax is an example. For 2012, you pay 6.2% tax on Social Security tax is an example. For 2012, you pay 6.2% tax on wages up to a maximum wage of wages up to a maximum wage of $97,500$97,500. Therefore:. Therefore:

A person who makes A person who makes $30,000 $30,000 a year pays $1,860 a year pays $1,860 (30,000*.062) (30,000*.062) in in tax or tax or 6.2% 6.2% of wages.of wages.

A person who makes A person who makes $200,000 $200,000 a year pays $6,045 a year pays $6,045 (97,500*.062) (97,500*.062) in tax or in tax or 3% 3% of wages.of wages.

A person who makes A person who makes $500,000 $500,000 a year still pays $6,045 a year still pays $6,045 in tax in tax (97,500*.062) (97,500*.062) or or 1.2% 1.2% of wages.of wages.

TAX APPLICATIONS:TAX APPLICATIONS:

1.1. Personal Income Tax Personal Income Tax ProgressiveProgressive

2.2. Sales TaxSales TaxRegressive & ProportionalRegressive & Proportional

3.3. Corporate Income Tax Corporate Income Tax (28% for all (28% for all corporations)corporations)

RegressiveRegressive

4. 4. Property Taxes: Property Taxes: Pay for CC schools & (based on Pay for CC schools & (based on value of property) Is this fair for everyone? value of property) Is this fair for everyone?

RegressiveRegressive

Identify whether progressive, regressive, or proportionalIdentify whether progressive, regressive, or proportional

& Proportional& Proportional

& Proportional& Proportional

ANY QUESTIONS?ANY QUESTIONS?