Government, Fiscal, and Monetary Policy

Economics Day 7

Should the government have the power to tax?

• Governments collect revenue through taxation in order to pay for government spending.

• Government taxes and spending is called Fiscal Policy that facilitates economic growth.

What is a tax?

• Tax – a required payment to a local, state, or national government

• Revenue – income received by a government through taxation

• Tax base – income, property, good, or service that is subject to a tax

• Incidence of a tax – the final burden of a tax, i.e. if a good is taxed, does that burden fall on the supplier or the consumer?

Tax Structures

• What are the types of tax structures and how are they implemented at federal, state, and local levels?

There are three tax structures:

• Tax structures video: http://www.youtube.com/watch?v=t-qrIrHIT6E

• Proportional Tax – percentage of income paid in taxes remains the same for all income levels, i.e. a “Flat Tax” (example: state property taxes)

• Progressive Tax – A tax for which the percentage of income paid in taxes increases as income increases. (example: state and federal income taxes)

• Regressive Tax – A tax for which the percentage of income paid in taxes decreases as income increases. (example: state and local sales tax)

Types of Federal Taxes

• Individual Income Tax – nearly half of the federal government’s revenue is generated through this “pay as you earn” taxation. This tax is progressive: the tax rate increases at increasing income levels.

• Corporate Income Tax – roughly ten percent of revenue is generated through corporate taxes. These taxes are less lucrative than they might appear because corporations claim numerous deductions that lower their taxable income.

• Social Insurance taxes (FICA) – taxes that support two federal programs, Social Security and Medicare.

• Excise taxes – general tax on the sale or manufacture of goods like gasoline, cigarettes, alcoholic beverages, media services, etc.

• Estate and gift taxes – tax on the total value of the property of a person who has died. A progressive tax, the more wealthy the estate ($750,000 +), the greater the tax rate.

How are federal taxes spent?

• Basic income tax: http://www.youtube.com/watch?v=OGVJfcSckUs&list=PLyOqA8x1tRDeaNArVX0ETWzTgz1L2haQB

• Using BYOT, identify how federal taxes are used. (5 mins)

Where do the federal tax dollars go?

Federal Expenditures/Fiscal Policy

Mandatory Spending

• o Entitlement Programs

• Social Security

• Medicare

• Medicaid

• Food stamps, child nutrition

• Benefits & pensions for federal employees

• Veterans’ benefits

• Unemployment insurance

Federal Expenditures/Fiscal Policy

Discretionary Spending

• o Defense spending

• o Education

• o Scientific & technology research

• o Federal law enforcement

• o Housing

• o National Parks

• o Foreign Aid / Disaster aid

• Aid to State & Local Governments

Types of State Taxes

• Sales Tax – a tax on goods and services in place in nearly every state

• Excise Taxes – taxes on certain goods, often called a “sin tax” because they (in theory) discourage harmful behavior like smoking

• Income Taxes – most states (not including Texas) impose an additional income tax on their citizens

• Business Taxes – most states collect taxes from companies licensed and operating in the state

Do all states have a state income tax?

• Using BYOT, identify all the states that do not have a state income tax. (5 mins)

Activity 2

• Using your BYOT, identify how taxes collected within the state are spent? (5 mins)

How are state taxes used?

State Expenditures:

• Education

• Public safety (police, corrections)

• Public welfare (hospitals, health agencies)

• Highways

• Governmental Administration

• Arts & Recreation

Types of Local Taxes

• Property taxes – the most significant of local government revenue, property taxes are placed on real property (land, houses, etc.). Property tax rates can vary greatly from one city to another

• Sales and Excise taxes – local governments often impose their own city sales and excise taxes

• Income taxes(in some cities)

Activity

• How are local tax dollars spent?

• Use BYOT to answer this question. (5 mins)

Local tax expenditures

• Education

• Utilities

• Police and Firefighters

• Libraries

• Hospitals & Public Health

• Elections

• Record Keeping

• Arts & Recreation

Will you pay your income taxes?

• Video: http://www.youtube.com/watch?v=DtCfOMl3qo0

Fiscal Policy

• The use of government spending and revenue collection to influence the economy.

• Because of the size and resources of the Federal government, government can have a tremendous impact on economic activity. The two greatest fiscal tools available to government are spending and taxation.

• Views of how and when government should utilize fiscal policy have been controversial in the past and continue to prompt debate today.

Views on when to fiscal policy

• Classical Economics: The belief of traditional economists of the 18th and 19th centuries that, in a free market, people act in their own self-interest, causing prices to rise or fall so that supply and demand will always return to equilibrium.

• Keynesian Economics: John Maynard Keynes believed that government was just as important as individuals and businesses in the functioning of the economy. As such, he argued for governments to use fiscal policy to generate demand in difficult economic times.

When are fiscal policies used?

• Expansionary fiscal policies

• Contractionary fiscal policies

• Video: https://www.youtube.com/watch?v=QbxXns0zero

The Federal Budget

• The federal budget is a written document indicating the amount of revenue the government expects to collect and how much it plans to spend in the upcoming fiscal year

• A number of government agencies help create and evaluate the budget, including:

• o Office of Management and Budget (OMB) – part of the Executive Office of the President, the OMB is responsible for preparing and managing the federal government’s budget.

• o Congressional Budget Office (CBO) – provides Congress independent economic information in order to better inform policymakers’ decisions.

• Video: https://www.youtube.com/watch?v=cviXliRD6r8

Monetary Policy

• BYOT: What is monetary policy? Who implements it and why?

The Federal Reserve System

• The Federal Reserve System was created in order to stabilize the nation’s banking system by providing loans to banks and by using monetary policy to influence interest rates and lending. The FED is the United States’ central bank

The Structure of the Federal Reserve System

• Prezi: http://prezi.com/wqacxmodb6fa/federal-reserve-system/

• Using BYOT, locate a diagram of the FED structure and draw it in your notes.

• Video: https://www.youtube.com/watch?v=8Hq5zw4YaZQ

12 Districts/Banks

Three Tools of Monetary Policy

•Reserve Requirements

•Discount Rate & Federal Funds Rate

•Open Market Operations

Reserve Requirements

• Because banks hold in reserve only a fraction of their funds, just enough to meet their customers needs in an average day. The rest of banks’ deposits are lent out . . .

• The Fed requires banks to report daily about their reserves and lending activities. This information helps the Fed determine how much money to inject into the system.

• Required Reserve Ratio (RRR) – this is the amount of a depositors’ deposit that banks must keep on reserve. By manipulating this figure, the Fed can influence the economy.

Discount Rate & Federal Funds Rate• The Fed is referred to as the “lender of last resort,” because banks

normally loan money to each other (federal funds). However, banks can also borrow from the Fed itself.

• The Discount Rate is the interest rate that the Fed charges on loans to other banks and financial institutions. Because banks constantly borrow money from the Fed in order to maintain their required reserves, the Fed can manipulate lending practices by changing the discount rate.

• The Fed reduces the discount rate if it wants to encourage increased lending. When banks know they can borrow money from the Fed more cheaply because of a low discount rate, they are more willing to lend

• If the Fed increases the discount rate, it hopes to reduce lending by making borrowing more expensive for banks.

• The Federal Funds Rate – the interest rate that banks charge each other for inter-bank loans. The rate is set by the Federal Open Market Committee (FOMC).

Open Market Operations

• The buying and selling of government securities to alter the supply of money, open market operations are the most commonly used monetary policy tool.

• Bond purchases – increases reserves in the banking system causing banks to increase lending and expansion of the money supply

• Bond sales – the Fed is able to remove reserves from the banking system by selling government securities. This causes banks to reduce their lending, causing the money supply to contract.

Other Fed Responsibilities

• Check clearing – the process by which banks record whose account gives up money and whose account receives money when a customer writes a check. The Fed clears ~20 billion checks per year.

The Fed & the Money Supply• Using monetary policy tools, the Fed can pursue economic expansion or

economic contraction.

• Easy Money Policy – policies that increase the money supply by decreasing interest rates and encouraging borrowing and spending. Easy money policies include lowering the Discount Rate, lowering the Required Reserves Rate, and buying bonds.

• Tight Money Policy – policies that decrease the money supply by raising interest rates and encouraging saving. Tight money policies include raising the Discount Rate and the RRR, and purchasing bonds.

• Complications

• Just as with fiscal policy, to be effective, monetary policy was be well timed. This requires quality analysis and projections of future economic trends, information that is not always obvious or available.