Government Finance

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Government Finance
We made it!
ECO 105 Lecture 4.8 3 December 2008
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Some Fiscal History

• Government has become an increasingly prominent
  feature of the US economy.
• Government (at all levels) absorbs 1/3 of GDP.
• Contrary to popular opinion, the wealthy pay by
  far the largest share of income taxes.
• Top 1 of taxpayers pay gt 1/3 of income taxes
  top 25 pay gt 80.

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Politics at Work
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• Government spending as a percentage of GDP has
  grown tremendously since WWII.
• The growth has been propelled largely by growth
  in transfer payments.

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Federal Receipts
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U.S. Government Expenditures
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Federal Government Outlays
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Social Security and Medicare

• As a percentage of federal government outlays
• Social Security 22.0
• Medicare 13.4

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Gross Federal Debt
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Change in Federal Debt
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Financing Government Spending

• All government spending must be financed either
  by tax revenue or by borrowing.
• The IRS collected more than 2.235 trillion in
  personal and corporate income taxes and FICA
  taxes in 2006.

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US Income Tax

• The largest share of federal revenue comes from
  the individual income tax.
• The US income tax is progressive - taxpayers with
  higher incomes pay a higher marginal tax rate.
• The top 5 of all taxpayers earned 32 of taxable
  income in 2001 and paid 53.3 of all income taxes.

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Fiscal Policy and the Economy

• Government policies affect the economy in a
  myriad of ways.
• Well consider only a couple.
• Change in income-tax rates . . .
• A change in transfer payments works like a
  negative change in income taxes.
• Change in government purchases . . .

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More Bang for the Buck

• The expenditures multiplier
• When government purchases rise, GDP increases and
  private incomes rise.
• Consumers spend part of the increase in income.
• Aggregate demand gets an additional boost.

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But We Must Remember!!!

• All government spending policies must be
  financed.
• Financing affects the total impact of any fiscal
  policy.
• How a policy is financed can affect the economy
  as much as the policy itself.

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Tax-Financed Purchases

• Suppose government increases G and finances
  higher spending by raising income taxes.
• Higher G shifts AD to the right.
• Higher taxes reduce C, shifting AD to the left.
• Net effect on AD is small, but probably positive

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Deficit-Financed Purchases

• Government increases G
• Finances by borrowing in the bond market
• Increased borrowing drives up the interest rate
• Investment may be crowded out
• AD increases by more than if tax-financed, but
  crowding out limits effect

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Money-Financed Purchases

• Government increases G
• Sells bonds, which are bought by the Fed
• Money supply increases
• No crowding out
• Monetary policy accommodates fiscal policy
• AD increases by the largest possible amount

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Fiscal Policy and the Business Cycle

• Discretionary fiscal policies arent very useful
  in smoothing business cycles.
• The political process works too slowly, and
  pork-barrel politics lead to bad policies.
• Automatic stabilizers work much better
• Unemployment insurance benefits
• Welfare payments
• Reductions in income taxes