Chapter 13 Flashcards
Federal Budget
is the annual statement of the federal
government’s outlays and revenues.
2 purposes of fed budget
- To finance the activities of the federal government
- To achieve macroeconomic objectives
Fiscal policy
is the use of the federal budget to achieve
macroeconomic objectives, such as full employment,
sustained economic growth, and price level stability.
gov budget surplus
revenues exceed outlays
gov budget deficit
If outlays exceed revenues
gov balanced budget
If revenues equal outlays
Government debt
is the
total amount that the
government borrowing.
It is the sum of past
deficits minus past
surpluses.
What are the effects of an income tax in the labour market
- changes full employment and potential GDP
- decreases supply of labour (shifts curve left) because the tax lowers the after tax wage rate
- Changes equilibrium
- when quantity of labour decreases potential gdp decreases and aggregate supply decreases
Tax wedge
The gap created between
the before-tax and after-tax
wage rates
tax wedge and taxes on expenditure
Taxes on consumption expenditure add to the tax wedge.
The reason is that a tax on consumption raises the prices
paid for consumption goods and services and is equivalent
to a cut in the real wage rate.
Taxes and the Incentive to Save and Invest
- A tax on capital income lowers the quantity of saving and
investment and slows the growth rate of real GDP
real after-tax interest rate
- The interest rate that influence saving and investment when there is taxation
- The real after-tax interest rate subtracts the income tax
paid on interest income from the real interest - Taxes depend on the nominal interest rate. So the true tax
on interest income depends on the inflation rate
Laffer Curve
The relationship between
the tax rate and the amount
of tax revenue collected
- slopes up till T*, than slopes down
(till T rise in taxes will increase tax revenue after it will decrease)
Fiscal Stimulus
- the use of fiscal policy to increase
production and employment - Can be Automatic or Discretionary.
Automatic fiscal policy
fiscal policy action triggered
by the state of the economy with no government action
Discretionary fiscal policy
a policy action that is
initiated by an act of Parliament.
Two items in the government budget change automatically
in response to the state of the economy
▪ Tax revenues
▪ Outlays
Automatic Changes in Tax Revenues
- Parliament sets the tax rates that people must pay.
- The tax dollars people pay depend on tax rates and incomes.
- But incomes vary with real GDP, so tax revenues depend on real GDP.
- When the real GDP increases in an expansion, tax revenues increase.
- When real GDP decreases in a recession, tax revenues decrease.
Outlays
- The government creates programs that pay benefits to
qualified people and businesses. - These transfer payments depend on the economic state of
the economy. - When the economy is in an expansion, unemployment
falls, so unemployment benefits decrease. - When the economy is in a recession, unemployment rises,
so unemployment benefits increase.
Automatic Stimulus
- In a recession, tax revenues decrease and outlays increase.
- So the budget provides an automatic stimulus that helps shrink the recessionary gap.
- In a boom, tax revenues increase and outlays decrease.
- So the budget provides automatic restraint that helps shrink the inflationary gap.
structural surplus or deficit
the budget balance that would occur if the economy were at full employment
and real GDP were equal to potential GDP
cyclical surplus or deficit
- the actual surplus or
deficit minus the structural surplus or deficit - occurs purely because real GDP does not equal potential GDP
Most discretionary fiscal stimulus focuses on its effects on …
aggregate demand
Two main fiscal multipliers
- Government expenditure multiplier
- Tax multiplier
government expenditure multiplier
- is the quantity effect of a change in government expenditure on real GDP
- if crowding out effect dominates multiplier is <1, and the consensus is that is the case
tax multiplier
- the quantity effect a change in taxes
on aggregate demand - The supply-side effects of a tax cut probably dominate the demand-side effects and make the overall tax multiplier larger than the government expenditure multiplier
Time Lags (3)
The use of discretionary fiscal policy is seriously
hampered by three time lags
1.) Recognition lag
2.) Law-making lag
3.) Impact lag
Recognition lag
the time it takes to figure out that
fiscal policy action is needed
Law-making lag
the time it takes Parliament to pass
the laws needed to change taxes or spending
Impact lag
—the time it takes from passing a tax or
spending change to its effect on real GDP being felt
