Unit III: Fiscal Policy

Fiscal Policy

-Two option: taxes and spending

-Taxes- government can increase or decrease

-Spending- government can increase or decrease

Deficits, Surpluses, Debt

-Balanced budget: revenues= expenditures

-Budget deficit: revenues < expenditures

-Budget surplus: revenues > expenditures

-Government debt: sum of deficit-  of surpluses

-Government must borrow money when it runs a budget deficit

- Government borrows from individuals, corporation (both in the form of taxes), financial institutions, foreign entities or foreign government

Fiscal Policy Two Options

-Discretionary fiscal policy (action)

-Expansionary fiscal policy- deficit

-Contractionary fiscal policy- surplus

-Non-discretionary fiscal policy (no action)

-Discretionary: Increasing or decreasing government spending resulting in the economy to return to full employment.

-Automatic: Unemployment compensation and marginal tax rates.

Takes place without policy makers having to respond to current economic problems.

-Expansionary fiscal policy (“Easy”:

        i.            Combat a recession

      ii.            Increase government spending

    iii.            Decrease taxes

-Contractionary fiscal policy (“Tight”)

        i.            Combats inflation

      ii.            Decrease government spending

    iii.            Increase taxes

Automatic or Built-in Stabilizers

-Anything that increases the government deficit during recession yet increases budget surplus during inflation without requirement explicit action by policy maker

Examples: unemployment compensation, Social Security, Medicare/ Medicaid, Welfare

Progress Tax System

-Average tax rate (tax revenue/ GDP) rise with GDP

Proportional Tax System

-Average tax rate remains constant as GDP

Regressive Tax

-Average tax rate falls with GDP