What is a Fiscal Policy?What is a Fiscal Policy?

Government spending and taxation to achieve full employment without inflation

©©1999 South-Western College Publishing

Legislative Mandates

Employment Act of 1946

– Federal Governments responsibility to ensure price stability and full-employment

– Utilize Fiscal and Monetary policy to achieve this goal

Who decides to Tax or Spend??

The legislative branch – It is in the Constitution – Article 1– The President proposes a budget each year

during the “State of the Union address”. Congress approves/denies some or all of the budget. Increases or decreases in Taxes must be passed by the

House of Representatives.

Everyone has a budget – even the Federal Govt.

Revenues = SpendingBalanced Budget

Revenues > SpendingBudget Surplus

Revenues < SpendingBudget Deficit

Revenues mainly from Taxes. Some comes from Tariffs, fees, and other levies on goods and services

Americans are living longer and having fewer children

Consequently, fewer workers are available

to support each Social Security recipient

1960: 5.1 to 1 Today: 3.3 to 1 2040: 2 to 1

Source: Social Security Administration, March 2006

Difference between Deficits and Debt

Deficit - when a budget is created and spending is greater than revenues.

Debt - the accumulated borrowing to cover deficits.

National Debt (estimate) - $8,981 Trillion.

Relevant Numbers on Federal Debt

August 24, 2007

Information comes from the Concord Coalitionwww.concordcoalition.org/

issues/feddebt/debt-facts.html

The National Debt:

As of August 24, 2007, the total outstanding debt was $8.981 trillion, which is approximately 65% of U.S. Gross Domestic Product.  This amounts to a share of over $29,000 per citizen.

The Congressional Budget Office (CBO) August 2007 baseline projects that the national debt will exceed $10 trillion by 2010 and will reach $12.870 trillion in 2017

The national debt can be divided into $5.055 trillion of publicly held debt (domestic and foreign), and $3.926 trillion of debt held by government accounts (trust funds), the largest of which is Social Security.

Because trust fund debt is a matter of internal governmental bookkeeping, economists focus on the publicly held debt.  It is this number that reflects the impact of federal borrowing on the economy and the budget.

Publicly Held Debt:

The publicly held debt is currently $5.055 trillion, a historic high in nominal terms.

A more important measure of the debt is its size in relation to the nation's economy, generally stated in terms of Gross Domestic Product (GDP). In CBO's baseline projection, accumulated federal debt held by the public will equal 36.4% of GDP in 2007. 

Publicly Held Debt:

Roughly 90 percent of the publicly held debt consists of marketable securities--Treasury bills, notes, bonds, and inflation-indexed issues (called TIPS).  The remaining 10 percent comprises non-marketable securities, such as savings bonds and securities in the state and local government series, which are nonnegotiable, nontransferable debt instruments issued to specific investors.

By 2017, CBO projects publicly held debt to equal 25.2% of GDP.  If materialized, this would be a post-World War II low.  Previously, its post-World War II high was 109% of GDP in 1946, and its post-WWII low was reached in 1974 at 24% of GDP.

Publicly Held Debt:

Under the Government Accountability Office's (GAO) Long-Term Budget Scenario, publicly held debt will be 62.7% of GDP by 2020 and 250.3% of GDP by 2040. 

Foreign Holdings of Debt:

As of June 2007, domestic investors owned 55% ($2.724 trillion) of outstanding public debt and foreign investors held 45% ($2.219 trillion) of outstanding public debt.

The amount of the debt held by foreigners is at a historic high.  As of June 2007, foreign investors held $2.219 trillion of Treasury Securities, $1.469 trillion of which is held by official institutions.

As of June 2007, Japan and China were the two largest foreign holders of treasury securities with $612.3 billion and $405.1 billion respectively

Foreign holdings of Treasury securities have increased by more than $1.049 trillion since 2000.

Interest on the Publicly Held Debt:

Every borrowed dollar carries an interest cost. The most direct impact of public debt on the federal budget is, therefore, the amount of money taxpayers must come up with each year to finance past borrowing.

According to the CBO August 2007 Baseline, net interest on the publicly held debt in fiscal year 2007 is expected to equal $235 billion -- roughly 8.6% of the federal budget.

Spending for interest on the debt in fiscal year 2007 ($235 billion) is expected to equal 20.1% of all personal income tax revenue and more than the entire federal share of the Medicaid program in fiscal year 2007 ($192 billion).

Interest on the Publicly Held Debt:

During the 1980s and 90s, before the 1998-2001 surpluses, interest regularly consumed 13 percent or more of the federal budget a year, reaching a high point of 15.4 percent in 1996.

For fiscal year 2007, net interest on the publicly held debt is expected to equal 1.7 percent of GDP. Its recent high point was 3.3 percent of GDP in 1991.

Under GAO's long-term budget scenario, net interest costs will reach 2.9% of GDP by 2020 and 11.6% of GDP by 2040.

Trust Fund Debt:

While trust fund debt does not have the same economic and budgetary effects as publicly held debt, it is nevertheless a relevant, if incomplete, indicator of future burdens such as Social Security, Medicare and federal government pension payments.

As explained by the GAO: "Because debt held by the trust funds is neither equal to future benefit payments, nor a measure of the commitments of the current system, it cannot be seen as a measure of this future burden. Nevertheless, it provides an important signal of the existence of this burden." [1]

As a technical matter, trust fund balances are credited with interest. However, trust fund interest is simply a credit of IOUs to the respective trust fund. It does not involve an outlay of federal dollars and thus has no economic or budgetary effect.

Trust Fund Debt:

According to the July 2007 Monthly Treasury Statement, the five largest trust funds are:

– Social Security's Federal Old Age and Survivors Insurance, $1.965 trillion.

– Civil Service Retirement, $677 billion.

– Department of Health and Human Services Federal Hospital Insurance, $320 billion.

– Social Security's Federal Disability Insurance, $210 billion.

– Military Retirement Fund, $194 billion

Gross Debt and the Statutory Limit:

The debt subject to limit is the maximum amount of money the government is allowed to borrow without receiving additional authority from Congress.

The current statutory debt limit is $8.965 trillion. Congress has approved three increases in the

statutory debt limit totaling $3.015 trillion since 2002. The most recent legislation adopted by Congress

provided for an additional $781 billion increase in the debt limit

National Debt

What is the Federal Budget today?

http://www.heritage.org/Research/Budget/upload/83722_1.pdf

Two types of Fiscal Policies of Spending and Taxation

Discretionary Fiscal Policy– Changes in Taxes or Spending at the “option” of the

Federal Government.– These changes do not occur automatically- they must be

legislated.

Spending on the War on Terrorism, poverty programs, Student financial aid, Homeland Security, etc.

Tax cuts for the “wealthy”, Capital gains taxes, change in Social Security/Medicare taxes

Discretionary Spending 08’

Go to this website for interactive poster

www.thebudgetgraph.com/poster/

The Two types of Fiscal Policies Spending and Taxation

Nondiscretionary Fiscal Policy– Built-in stabilizers -automatic changes in G and T as the economy

changes.– These do not require new legislation – already embodied in law

In a Recession – Government spending for some programs INCREASES. As the economy improves, spending for these programs DECREASES

Examples: Unemployment Compensation, Food Stamps, Social Security, Medicare

– Progressive Tax System In a Recession– Incomes decline and people pay less of there income

in taxes - retain more to spend During periods of Inflation, as incomes rise people pay more of their

income in taxes – now they have LESS to spend

1965 1985 2006

66%

27%

7%

44%

14%

42% 38%

8%

54%

Mandatory DiscretionaryNet Interest

Source: Congressional Budget Office, October 2006

Mandatory spending is consuming a

growing share of the budget

NOTE: Numbers may not add up due to rounding.

Change in composition of discretionary spending

1965 1985 2006

66%34%

61%39%

50% 50%

Defense Non-defense

Source: Congressional Budget Office, October 2006

Non-Discretionary Spending

Insert Progressive Tax Schedule

U.S. Tax Brackets-2006

Single Taxpayer Rate

$0-$7,550 10%

$7,551-$30,650 15%

$30,651-$74,200 25%

$74,201-$154,800 28%

$154,801-$336,550 33%

$336,551-and above 35%

Progressive Tax Structure and You

U.S. Tax Brackets-2006

Single TaxpayerRate

$0-$7,550 10%

$7,551-$30,650 15%

$30,651-$74,200 25%

$74,201-$154,800 28%

$154,801-$336,550 33%

$336,551-and above

35%

What this means…

If you do your taxes and after Credits and Deductions your Adjusted Gross Income is$100,000 (pretty good, huh!)

On your first 7,550 you pay 10% = $755From $7551 to $30,650 you pay 15% =$3,465From $30,361 to $74,200 you pay 25% = $10,960From $74,201 to $100,000 you pay 28% = $7,224

Total Federal Income Tax $22,404

You are in the 28% Tax Bracket, BUT your Effective Tax Rate is 22.40%

Percentiles Ranked by AGI Adjusted Gross Income

Threshold on Percentiles Percentage of Federal

Personal Income Tax Paid Top 1% $364,657+ 39.38% Top 5 % $145,283 59.67% Top 10% $103,912 70.30% Top 25% $62,068 85.99% Top 50% $30,881 96.93% Bottom 50% < $30,881 3.07%

Who bears the burden of Federal Income Taxes??

How many days do we work to pay our taxes?

www.taxfoundation.org/taxfreedomday/

What is aRecessionary Gap?What is aRecessionary Gap?

The amount by which Aggregate Demand falls short of a full employment equilibrium, thus giving high unemployment

©©1999 South-Western College Publishing

AggregateDemand/Aggregate Supply Recession

Price

Level

Gross Domestic Product

Full Employment (Fe) LRAS

(AS)SRAS(Fe)

(AD)

GDP1

P(1)

RecessionaryGap

Fiscal policy to help solve a recessionary gap

Raise government spending Lower taxes Attempting to expand or stimulate the economy Remember, multiplier effects

“EXPANSIONARY”

REMEMBERWe want to get Aggregate Demand moving to the Right – Increasing

GDP

AD

What is anInflationary Gap?What is anInflationary Gap?

The amount by which Aggregate Demand exceeds the full employment equilibrium, thus a booming economy, leading to demand pull inflation.

©©1999 South-Western College Publishing

AggregateDemand/Aggregate SupplyInflation

Price

Level

Gross Domestic Product

Full Employment (Fe)LRAS

(AS)SRA

S

(Fe)

(AD)

Inflationary Gap

P(1)

This is where we want to be!!

Fiscal policy to help solve an inflationary gap

Lower government spending Raise taxes Attempting to contract or slow down the economy

– “CONTRACTIONARY”

REMEMBER

We want to get Aggregate Demand moving to the Left (down) – Increasing GDP

AD

If the government is looking to close an inflationary gap, which would be the preferred method?

A. Lower taxes and increase govt. spending

B. Raise taxes and increase govt. spending

C. Lower taxes and decrease govt. spending

D. Lower taxes and don’t change govt. spending

E. Raise taxes and decrease govt. spending

If the government is looking to close a recessionary gap, which would be the preferred method?

A. Lower taxes and increase govt. spending

B. Raise taxes and increase govt. spending

C. Lower taxes and decrease govt. spending

D. Lower taxes and don’t change govt. spending

E. Raise taxes and decrease govt. spending

“Crowding Out” Effect

Government INCREASES spending WITHOUT raising taxes to pay for this new spending

Where does this money come from?

“Crowding Out” Effect

Government must borrow this money

Government enters: “The Market for Loanable Funds”

– Not an actual place – represents the total demand (from C, I, G, foreigners) for money in the financial system and the total supply of funds (from C, I, G, foreigners)

Competes for funds along with individuals, business and other governments

– What effect does this have on the Interest Rate?”

“Crowding Out” Effect

Quantity of Loanable Funds

MARKET FOR LOANABLE FUNDS

Real InterestRate

D.L.F (C + I)

S.L.F (C+I)

Q*

i*

D.L.F. (C + I + G)

i1

Q1

“Crowding Out” with addition of “G”

“Crowding Out” Effect

Follow the reasoning:– Government borrows money to increase spending –

Aggregate Demand INCREASES– Interest rate INCREASES due to “Crowding Out”– Adversely affects “C” and “I” – Aggregate Demand

DECREASES– Dollar APPRECIATES in value – Imports increase and

Exports decrease – Aggregate Demand DECREASES

WHAT IS THE NET EFFECT ON THE ECONOMY???