Chapter 15Chapter OutlineThe Government Budget: Some Facts and FiguresSlide 4Figure 15.2 Taxes: Federal, state, and local, 1940-2005Slide 6Table 15.2 Government Receipts and Current Expenditures, 2005Slide 8Slide 9Government Spending, Taxes, and the MacroeconomySlide 11Slide 12Slide 13Figure 15.5 Full-employment and actual budget deficits, 1960-2005Slide 15Slide 16Slide 17Slide 18Slide 19Government Deficits and DebtSlide 21Figure 15.6 Ratio of Federal debt to GDP, 1939-2005Slide 23Slide 24Slide 25Slide 26Slide 27© 2008 Pearson Addison-Wesley. All rights reservedChapter 15Government Spending and its Financing© 2008 Pearson Addison-Wesley. All rights reserved15-2Chapter Outline•The Government Budget: Some Facts and Figures–Outlays and receipts, deficit•Government Spending, Taxes, and the Macroeconomy–Aggregate demand, capital formation and labor supply•Government Deficits and Debt (financing)•Deficits and Inflation(skip)© 2008 Pearson Addison-Wesley. All rights reserved15-3The Government Budget: Some Facts and Figures •Government outlays; three categories of government expenditures (1/3 of GDP)–Government purchases (G)•1/6 investments and 5/6 expenditures–Transfer payments (TR): not exchange for goods•social security benefits, pensions for government retirees, welfare payments–Net interest payments (INT)•Interest payments on bonds – Interest earned from loans–Also: Subsidies less surpluses of government enterprises; relatively small, so we ignore it© 2008 Pearson Addison-Wesley. All rights reserved15-4•Taxes–Four principal categories•Personal taxes (income taxes and property taxes)•Contributions for social insurance•Taxes on production and imports •Corporate taxesThe Government Budget: Some Facts and Figures© 2008 Pearson Addison-Wesley. All rights reserved15-5Figure 15.2 Taxes: Federal, state, and local, 1940-2005© 2008 Pearson Addison-Wesley. All rights reserved15-6•Taxes–The composition of outlays and taxes: the Federal government versus state and local governments•To see the overall picture of government spending, we usually combine Federal, state, and local government spending•But the composition of the Federal government budget is quite different from state and local government budgets (Table 15.2)The Government Budget: Some Facts and Figures© 2008 Pearson Addison-Wesley. All rights reserved15-7Table 15.2 Government Receipts and Current Expenditures, 2005© 2008 Pearson Addison-Wesley. All rights reserved15-8•Deficits and surpluses–Deficit  outlays – tax revenues government purchases  transfers + net interest – tax revenues  G  TR  INT – T (15.1)–Primary deficit  outlays – net interest – tax revenues  government purchases + transfers – tax revenues  G  TR – T (15.2)-- Current deficit = Deficit – government investments = Current expenditures + transfers + net interest – tax revenue-- Primary current deficit = Current deficit – net interest-- Primary: excluding net interest-- Current: excluding investments (capital goods)The Government Budget: Some Facts and Figures© 2008 Pearson Addison-Wesley. All rights reserved15-9•Deficits and surpluses–The total deficit tells the amount the government must borrow to cover all its expenditures–The primary deficit tells if the government’s receipts are enough to cover its current purchases and transfers–The primary deficit ignores interest payments, because those are payments for past government spending (Fig. 15.3)The Government Budget: Some Facts and Figures© 2008 Pearson Addison-Wesley. All rights reserved15-10Government Spending, Taxes, and the Macroeconomy •Fiscal policy and aggregate demand–An increase in government purchases increases aggregate demand by shifting the IS curve up–The effect of tax changes depends on the economic model•Classical economists accept the Ricardian equivalence proposition that lump-sum tax changes have no effect on national saving or on aggregate demand•Keynesians think a tax cut is likely to increase consumption and decrease saving, thus increasing aggregate demand© 2008 Pearson Addison-Wesley. All rights reserved15-11Government Spending, Taxes, and the Macroeconomy •Fiscal policy and aggregate demand–Classicals and Keynesians disagree about using fiscal policy to stabilize the economy•Classicals oppose activist policy while Keynesians favor it•But even Keynesians admit that fiscal policy is difficult to use–There is a lack of flexibility, because much of government spending is committed years in advance–There are long time lags, because the political process takes time to make changes–Fiscal policy may not be effective, then how to stabilize the economy?© 2008 Pearson Addison-Wesley. All rights reserved15-12Government Spending, Taxes, and the Macroeconomy •Fiscal policy and aggregate demand–Automatic stabilizers and the full-employment deficit•Automatic stabilizers cause fiscal policy to be countercyclical by changing government spending or taxes automatically•One example is unemployment insurance, which causes transfers to rise in recessions•The most important automatic stabilizer is the income tax system, since people pay less tax when their incomes are low in recessions, and they pay more tax when their incomes are high in booms•A stabilizer of macro economy not a stabilizer of budget balance. So need to get a less(more) biased (consistent) deficit measure?© 2008 Pearson Addison-Wesley. All rights reserved15-13Government Spending, Taxes, and the Macroeconomy •Fiscal policy and aggregate demand–Because of automatic stabilizers, the government budget deficit rises in recessions and falls in booms•The full-employment deficit is a measure of what the government budget deficit would be if the economy were at full employment•So the full-employment deficit doesn’t change with the business cycle, only with changes in government policy regarding spending and taxation•The actual budget deficit is much larger than the full-employment budget deficit in recessions (Fig. 15.5)© 2008 Pearson Addison-Wesley. All rights reserved15-14Figure 15.5 Full-employment and actual budget deficits, 1960-2005© 2008 Pearson Addison-Wesley. All rights reserved15-15Government Spending, Taxes, and the Macroeconomy •Government capital formation–Fiscal policy affects the economy through the formation of government capital—long-lived physical