Unit 3 - Fiscal Policy, Automatic Stabiliziers, Tax System (2-29-16)

Fiscal Policy: changes in the expenditures or tax revenues of the federal government

2 Tools of Fiscal Policy

• Taxes: government can increase or decrease taxes
• Spending: government can increase or decrease spending

Deficits, Surpluses, and Debt

Balanced Budget: Revenue = Expenditures
Budget Deficit: Revenues < Expenditures
Budget Surplus: Revenues > Expenditures
Government Debt: (Sum of all deficits - Sum of all surpluses)

Government must borrow money when it runs a budget deficit
They must borrow from:

• Individuals
• Financial Institutions
• Corporations
• Foreign entities or foreign government

Fiscal Policy Two Options

1) Discretionary Fiscal Policy (action)

• Expansionary Fiscal Policy - think deficit. Combats recession, increase government spending, decreases taxes.
• Contractionary Fiscal Policy - think surplus. Combats inflation, decrease government spending, increases taxes.

2) Non-discretionary Fiscal Policy (no action)

Discretionary vs. Automatic Fiscal Policies

Discretionary: increasing or decreasing government spending and/or taxes in order to return the economy to full employment. Discrestionary policy involves policy makers doing fiscal policy in response to economic problem.

Automatic: unemployment compensation and marginal tax rates are examples of automatic policies that help mitigate effects of recession and inflation. Automatic fiscal policy takes place without policy makers having to respond to current economic problems.

 Automatic or Built-in Stabilizers

• anything that increases governments budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policymakers.

Economic Importance:

• taxes reduce spending and aggregate demand
• reductions in spending are desirable when the economy is moving toward inflation
• increases in spending are desirable when economy is heading toward recession

Examples: 

• Medicare
• Medicaid
• Social Security
• Unemployment

 Tax System

Progressive Tax System:

• Average tax rate (Tax revenue / GDP) rises with GDP

Proportional Tax System:

• Average tax rate remains constant as GDP changes

 Regressive Tax System:

• Average tax rate falls with GDP