CHAPTER 15 FISCAL POLICY

Government Spending, Borrowing, and Taxation

Fiscal Policy: Government Spending

• 1 Samuel 2:7 and Mark 12:17 • Fiscal Policy: refers to the actions the government takes to affect output

(gross domestic product) and employment through the way it spends, taxes and borrows.

• To understand fiscal policy, you must understand the business cycle, the perpetual increase and decrease in real GDP (Chp 12). The goal of fiscal policy is to keep the cycle of economic decline and prosperity in check.

• Keynesian Economics: British economist John Maynard Keynes theory that because there are alternating periods of excessive and insufficient demand for the nation’s production cause the peaks and troughs in the business cycle. Therefore, the government should intervene in the economy to regulate demand. During periods of economic expansion, the government should seek to reduce its own purchases of goods and services and increase taxes, thereby decreasing consumers purchasing power and weakening demand.

Fiscal Policy: Government Spending 15A

• Governmental spending: The first tool the government can use in its effort to control the economy is to manage its own spending. There are (3) three issues when it comes to government spending: the size of the national budget (currently $3.6 Trillion), the programs that the government supports, and the way the dollars flow through the economy after they leave the government’s hands.

• The National Budget: pg 305, Fig. 15-2 Fed Government Spending 2007. www.usdebtclock.org (updated info). Largest portion (35%) of federal spending goes to income maintenance and other transfer payments.

Fiscal Policy: Government Spending 15A

• The Expenditure Multiplier: remember the Money Multiplier effect? See Figure 15-3 pg 306.

• Marginal Propensity to Consume (MPC): The portion of each dollar that the average person spends. If the average person spends 85 cents of each dollar he earns (85% of his income), the MPC is 0.85.

• Marginal Propensity to Save (MPS): The percentage of each dollar that the average consumer saves. The MPS will always be 1 minus the MPC.

Problems with Governmental Spending as a tool of Fiscal Policy• Four critical problems that make it difficult for the

government to control the economy: • Problem #1. Time Lags• Problem #2: An Uncertain Multiplier• Problem #3: Politics• Problem #4: The Source of Additional Spending• Fleecing the Nation: Reading pg 308: Read and discuss• In God We Trust? Pg 309 Psalm 118:8-9• Section Review 15A Questions 1-5 pg 310

Taxation 15B

• Sources of Fed Tax Revenues (4 main types): Figure 15-4 pg 311

• Personal Income Taxes: The greatest source of tax revenue for the federal government.

• Federal Insurance Contribution Act: (FICA): requires social security taxes, and the government also deducts these from paychecks before workers receive them.

• Corporate taxes. Company taxes• Excise taxes: a tax the government levies on the sale of

certain targeted consumer goods, such as gasoline, alcohol and cigarettes.

Types of Taxes• Proportional Taxes: is a tax in which all people, no matter how small or great

their income, pay the same percentage of their earnings. An example of this would be a flat tax.

• Progressive Taxes: is one that takes a greater percentage of a person’s income as his income increases.

• The ability-to-pay principle: defines a tax as being fair if the taxing authority levies it on those who have the ability to pay, regardless of who receives the benefits.

• Laffer Curve: pg 312 read and discuss. Increases in the tax rate may not lead to increases in tax revenue for the government.

• Regressive Taxes: is one that takes a smaller percentage of a person’s income as his income rises. For example, a gasoline tax is a regressive tax. Figure 15-5 pg 313

• The benefit principle: states that a tax should be paid by those who receive the benefits of the tax revenue.

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Problems with Taxation as a Tool of Fiscal Policy

• Problem #1. Effect on the National Work Ethic• Problem #2: Confusion in the Marketplace• John Maynard Keynes Biography: pg 314 Read

and discuss his contribution to Economics (which was in Fiscal Policy). The most basic need for is for government to regulate demand.

• Pork Barrel: Government spending legislated for political gain.

Governmental Borrowing 15C• Pump Priming: according to a Keynesian analogy, the government would

use debt to “prime” the economy (borrowing and spending), much as the old-time farmer primed a water pump with a bucket of water. After the pump began working, the farmer refilled the bucket and set it aside.

• Problems with Governmental Borrowing (Pump Priming) as a Tool of Fiscal Policy:

• Problem #1: There is no reserve bucket of Idle Money: for every dollar borrowed by the government there is one less dollar available to borrow by businesses

• Problem #2: Governmental Borrowing becomes “Addictive”. • Problem #3: Governmental Borrowing Destroys a Nation’s Future

Productivity. Opportunity benefit vs. Opportunity Cost. • Paying Down the Debt: Government spending and tax cuts pg 317 Read

and Discuss. • Section Review 15C: pg 318 questions 1-2 and Content Questions 1-5

pg 319

QUESTIONS?