Session 11

Fiscal 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
Potential Market Failures
Rival in Consumption?
Yes No
Excludable?

Yes Private Goods Natural Monopolies

No Common Resources Public Goods

Catagorize
• Cable TV
• Clothing • Fish in the ocean
• Congested non-toll roads • Ice cream
• Congested toll roads • National defense
• Environment • Tornado siren
• Fire protection • Uncongested non-toll roads
• Uncongested toll roads
 Rival in Consumption?
Yes No
Private Goods Natural Monopolies
• Clothing • Fire protection
Yes • Congested non-toll • Cable TV
Excludable?

roads • Uncongested toll

• Ice cream roads
Common Resources Public Goods
• Fish in the ocean • Tornado siren
No • Environment • National defense
• Congested toll • Uncongested non-
roads 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
Estate and Customs Federal Other
Excise taxes
gift taxes duties Reserve miscellaneou
3%
1% 1% deposits of s receipts
earnings 1%
2%

Indiv
Social idual
insur inco
ance Corporation
income taxes
me
and 7%
taxes
retire 43%
ment
recei
pts
42%

Source: Final Monthly Treasury Statement for FY2009

 Federal Government Funding
Other taxes and receipts
Corporation income taxes 5%
4%

Social insurance
Deficit
and retirement
receipts 40%
25%

Individual
income
taxes
26%

Source: Final Monthly Treasury Statement for FY2009

 Federal Government Expenditures
Note: “Other” includes many agencies, such as
Transportation, Housing and Urban Development,
Other
Education, Homeland Security, Justice, Energy, 15%
State, NASA, International Assistance Programs, Health and
Interior, Commerce, EPA and Corps of Engineers
Veterans Affairs Human
3%
Agriculture
Services
3% 21%
Labor
4%

Treasury
8%
Social Security
Administration
19%
Interest on the public
debt
10%
Defense-Military
17%

Source: Final Monthly Treasury Statement for FY2009

 State Government Revenue
Borrowing
Insurance 7%
trust revenue
19% Sales taxes
Utility revenue
1% and gross
From local receipts
governments 18%
Licenses Individual
1%
2% income
taxes
From 13%
federal Corporate income
government taxes
2%
21% Other taxes Property taxes
Charges and 1% 1%
miscellaneous
13%

http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
Texas Revenue
Insurance trust includes Insuran Federal
unemployment, retirement ce trust Govern
and workers comp funds revenue ment
24%
7% 23%
Other general revenue Local governments
1%

Interest earnings
Highways
0%
3% Sales
Hospitals
3%
Higher education
5%
taxes
Other taxes
6% Motor vehicle license
1%
28%
 State Government Expenditures
Insurance trust expenditure
Housing and community development 11%
Utility expenditure
1%
2%
Natural resources Educa
Other1%
13%
Corrections
tion
3% 31%
Police protection
1%
Highways
6% Health
Hospitals 3%
3%
Publi
c
welf
are
24%

http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
Texas Expenditures
Governmental administration Environment and housing Interest on general debt
Other and unallocable 2% 1% 1%
3%
Public safety
5%

Highways
Social services
10% and income
maintenance
34%
Capital outlay
11%

Insurance trust expenditure

13%
Libraries Other education Elementary & secondary
Higher
0% 2% 0% education
17%
 Local Governments Revenue
Insurance trust revenue
7%
Utility
revenue
14%
Special assessment
1%
Interest earnings
4% Proper
Sewerage
4%
Hospital charges
ty
7%
Education charges
taxes
3%
Other taxes 44%
4%
Corporate income taxes Individual income taxes
1% 3% Sales taxes
and gross
receipts
10%

http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
 Local Government Expenditures
Insurance trust
Utility expenditures expenditure
11% 2%

Other
9%
Education
Interest
Housing and community
4%
development
39%
3%
Administration
Parks and Recreation
2% 5%
Solid Waste
1%
Sewerage
3%
Corrections Public welfare
2% 3%
Police protection Health
5% Highways Hospitals 3%
4% 5%

http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
Structure of Taxes
Regressive

• % of income paid in taxes ↓ as income ↑

Progressive

• % of income paid in taxes ↑ as income ↑

Proportional

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

Structure of Taxes
Regressive

• Sales tax, Social Security taxes

Progressive

• U.S. federal income tax, estate taxes

Proportional

• Flat tax, Medicare tax

Budget Lingo
Balanced budget

• Revenues = Expenditures

Budget deficit

• Revenues < Expenditures

Budget surplus

• Revenues > Expenditures

Government debt

• Sum of all deficits – Sum of all surpluses

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 Deductions Spending

• Capital gains • Mortgage • Social
• Tariffs interest Security
• Student loan • NASA
interest • Food stamps
• Charitable • Defense
donations Spending
 Business Cycle
Real Long Run Growth
GDP Trend

Expansion

Recession

Time
Price Level Aggregate Supply

PL1

Aggregate Demand

YF Real GDP
Full Employment
Level of Output
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 American
Economic Recovery and
Stabilization Act Reinvestment
of 2008 Act of 2009
Renewabl Fund Making
Established the Troubled e energy
New
infrastruct Work Pay
and ure (roads, Pell tax credit
Assets Relief Program weatheriz bridges,
Grant and Child
e and mass Tax
(TARP) buildings transit) s 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?