Ch. 13: Fiscal PolicyThe Federal Budget and Fiscal PolicySlide 3Fiscal PolicyFederal Government RevenuesFederal Government SpendingSlide 7Federal Deficits and Public DebtThe Federal BudgetCBO PROJECTIONS OF OBAMA BUDGETSlide 11The National DebtSlide 13State and Local BudgetsSupply-Side EconomicsEffect of an increase in income tax rateTax Wedge ComparisonsFederal Income Tax Marginal RatesSlide 19Slide 20Historical average tax rates in U.S. by Income Quintile: Income Tax Only“The lucky duckies”Share of Federal Income Taxes Paid by QuintileThe Supply-Side: The Laffer Curve.The Laffer CurveLaffer Curve and Capital Gains TaxThe Supply-Side: Investment and SavingSlide 28Slide 29Slide 30Slide 32Stabilizing the Business CycleSlide 34Slide 35Slide 36Slide 37The Budget and the Business CycleCyclical and Structural BudgetCh. 13: Fiscal Policy•Federal budget process and recent history of outlays, tax revenues, deficits, and debts•Supply-Side Economics•Controversies on effects of deficits on investment, saving, and economic growth•Redistribution of benefits and costs across generations•Fiscal policy as a stabilization toolThe Federal Budget and Fiscal PolicyFederal budget•annual statement of the federal government’s outlays and tax revenues.•Two purposesofinance the activities of the federal governmentoachieve macroeconomic objectivesFiscal policy •the use of the federal budget to achieve macroeconomic objectives•Employment Act of 1946 it is the continuing policy and responsibility of the Federal Government to use all practicable means . . . to coordinate and utilize all its plans, functions, and resources . . . to promote maximum employment, production, and purchasing power.Timeline for Budget ProcessFebruary to March President submits budget request to Congress.May-August:House and Senate revise/amend proposalsSeptember House-Senate conference committees resolve differences and agree on final versions of spending bills. President signs or vetoes final bills.October 1 Beginning of fiscal year. Congress passes continuing resolutions to maintain funding for any agencies affected by appropriations bills that have not been passed and signed by the beginning of the fiscal year.Fiscal PolicyThe Council of Economic Advisers•Chaired by Christina Romer•monitors the economy •keeps the President and the public informed about the current state of the economy •forecasts of where it is heading.•source of data that informs the budget-making process.Congressional Budget Office•Forecasts effects of legislative changes on budget and economyFederal Government RevenuesFederal Government SpendingFederal Deficits and Public DebtBudgett = revenuet –outlayst•if Budgett > 0  budget surplus•if Budgett < 0  budget deficitDebtt = Debtt-1 - budgett-1•Budget deficits increase debt•Budget surpluses decrease debtSee national debt clockThe Federal BudgetCBO PROJECTIONS OF OBAMA BUDGETThe National Debt•The total government sector includes state and local governments as well as the federal government.•In 2008, when federal government outlays were about $3,200 billion, state and local outlays were a further $2,000 billion. •Most of state expenditures were on public schools, colleges, and universities ($550 billion); local police and fire services; and roads.•Most states have “balanced budget amendments”.State and Local BudgetsSupply-Side EconomicsFiscal policy aimed at increasing LAS•Income taxes affect LAS by affecting labor supply.•Higher income taxes reduce labor supply & reduce LAS•“Supply-siders” argue for low marginal tax rates.Graph the effect of an increase in income tax rate on•before-tax real wage rate, after-tax real wage rate.•Tax-wedge (difference between before and after tax wage)•Equilibrium employment•LASEffect of an increase in income tax rateTax Wedge ComparisonsFederal Income Tax Marginal RatesFederal Income Tax Marginal RatesHistorical average tax rates in U.S. by Income Quintile: Income Tax OnlySource: http://www.cbo.gov/doc.cfm?index=6133&type=0Includes individual income tax only.:“The lucky duckies”WSJ, November 2003.The most recent data from the IRS, in 2000, show that the top 5% coughed up more than half of total tax revenue. Specifically, we are talking about folks with adjusted gross incomes of $128,336 and higher being responsible for 56% of the tax take. Eyebrows raised? There's more. The top 50% of taxpayers accounted for almost all income tax revenue--96% of the total take.Share of Federal Income Taxes Paid by QuintileSource: http://www.cbo.gov/doc.cfm?index=6133&type=0Includes individual income tax only.:The Supply-Side: The Laffer Curve.Tax RevenueTax RatesThe Laffer CurveAs tax rates rise, taxable income may fall because•People reduce work hours•Tax avoidance increasesoLegal tax avoidance–Charities–Tax free bonds–Pension saving–Capital gains versus incomeoIllegal tax avoidance–Under-report income–Inflate deductionsLaffer Curve and Capital Gains TaxSource: http://time-blog.com/curious_capitalist/2008/01/do_capital_gains_tax_cuts_incr.htmlThe Supply-Side: Investment and SavingGDP = C + I + G + (X – M)GDP = C + S + T  I + G + (X – M) = S + T I = S + (T – G) + (M – X) Private saving PS = S + (M – X)Government Saving GS=T-G  I = PS + GSThe Supply-Side: Investment and SavingThe Supply-Side: Investment and SavingFiscal policy influences investment and saving in two ways:• Taxes affect the incentive to save and change the supply of loanable funds.• Government saving is a component of total saving and the supply of loanable funds.The Supply-Side: Investment and SavingA tax on capital income decreases the supplyof loanable fundsa tax wedge is driven between the interest rate and the after-tax interest rate Investment and saving decrease.The Supply-Side: Investment and SavingRicardo-Barro Equivalence•In above diagram, it is assumed that government budget does not shift PSLF curve.•Ricardo-Barro: oLarger deficits cause households to increase savings in order to cover future tax increases.oNet effect of larger deficit on SLF curve is zero because PSLF curve shifts right.oNo effect on investment or interest ratesoAll increases in deficits are offset by increased saving (decreased consumption).Stabilizing the Business CycleDiscretionary fiscal policy •action that is initiated by an act of