Overview of Fiscal Policy and Market Failures
Learn about fiscal policy decisions and their economic impact at different levels, understand the basics of a free enterprise system, and explore concepts like government expenditures, taxation, externalities, and potential market failures. Dive into categorizing goods based on rival consumption and excludability to analyze economic policies effectively.
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Session 11 Fiscal Policy Disclaimer: The views expressed are those of the presenters and do not necessarily reflect those of the Federal Reserve Bank of Dallas or the Federal Reserve System.
TEKS (15) Economics. The student understands the economic impact of fiscal policy decisions at the local, state, and national levels. The student is expected to: (A) identify types of taxes at the local, state, and national levels and the economic importance of each; (B) analyze the categories of revenues and expenditures in the U.S. federal budget; and (C) analyze the impact of fiscal policy decisions on the economy. (6) Economics. The student understands the basic characteristics and benefits of a free enterprise system. The student is expected to: (D) analyze the costs and benefits of U.S. economic policies related to the economic goals of economic growth, stability, full employment, freedom, security, equity (equal opportunity versus equal outcome), and efficiency.
Fiscal Policy Government spends money to provide goods and services Government pays for those expenditures through taxation and borrowing
Externalities Benefits or costs from a transaction extend beyond the buyer or seller Positive externalities Education Technology spillovers or patent protection Negative externalities Pollution
Potential Market Failures Rival in Consumption? Yes No Excludable? Yes Private Goods Natural Monopolies No Common Resources Public Goods
Catagorize Cable TV Clothing Congested non-toll roads Congested toll roads Environment Fire protection Fish in the ocean Ice cream National defense Tornado siren Uncongested non-toll roads Uncongested toll roads
Rival in Consumption? Yes No Private Goods Clothing Congested non-toll roads Ice cream Common Resources Fish in the ocean Environment Congested toll roads Natural Monopolies Fire protection Cable TV Uncongested toll roads Public Goods Tornado siren National defense Uncongested non- toll roads Yes Excludable? No
Potential for Market Failure Public goods are subject to a free-rider problem Lighthouse, basic research Common resources can lead to the tragedy of the commons Clean air and water, congested cities Role of property rights
Federal Government: Receipts Individual income taxes Social insurance taxes Corporate income taxes Other
Federal Government: Spending Social Security National defense Income security Medicare Health Net interest Other
Federal Government Revenue Customs duties 1% Other miscellaneous receipts 1% Federal Reserve deposits of earnings 2% Estate and gift taxes 1% Excise taxes 3% Social insurance and retirement receipts 42% Individual income taxes 43% Corporation income taxes 7% Source: Final Monthly Treasury Statement for FY2009
Federal Government Funding Other taxes and receipts 5% Corporation income taxes 4% Deficit 40% Social insurance and retirement receipts 25% Individual income taxes 26% Source: Final Monthly Treasury Statement for FY2009
Federal Government Expenditures Note: Other includes many agencies, such as Transportation, Housing and Urban Development, Education, Homeland Security, Justice, Energy, State, NASA, International Assistance Programs, Interior, Commerce, EPA and Corps of Engineers Other 15% Health and Human Services 21% Veterans Affairs 3% Agriculture 3% Labor 4% Social Security Administration 19% Treasury 8% Interest on the public debt 10% Defense- Military 17% Source: Final Monthly Treasury Statement for FY2009
State Government Revenue Borrowing 7% Sales taxes and gross receipts 18% Insurance trust revenue 19% Utility revenue 1% From local governments 1% Licenses 2% From federal government 21% Individual income taxes 13% Charges and miscellaneous 13% Property taxes 1% Other taxes 1% Corporate income taxes 3% http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
Texas Revenue Insurance trust includes unemployment, retirement and workers comp funds Insurance trust revenue 23% Federal Governmen t 24% Local governments 1% Other general revenue 7% Sales taxes 28% Interest earnings 3% Highways 0% Higher education 5% Hospitals 2% Other taxes 6% Motor vehicle license 1%
State Government Expenditures Utility expenditure 2% Insurance trust expenditure 11% Education 31% Other 13% Housing and community development 1% Natural resources 1% Public welfare 25% Police protection 1% Corrections 3% Highways 6% Hospitals 3% Health 3% http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
Texas Expenditures Governmental administration 2% Environmen t and housing 1% Interest on general debt 1% Other and unallocable 3% Public safety 6% Social services and income maintenance 34% Highways 10% Capital outlay 11% Higher education 17% Insurance trust expenditure 13% Libraries 0% Other education 2% Elementary & secondary 0%
Local Governments Revenue Insurance trust revenue 7% Utility revenue 14% Special assessment 1% Property taxes 44% Interest earnings 4% Sewerage 4% Hospital charges 6% Education charges 3% Sales taxes and gross receipts 10% Corporate income taxes 1% Other taxes 3% Individual income taxes 3% http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
Local Government Expenditures Insurance trust expenditure 2% Utility expenditures 11% Other 9% Education 39% Interest 4% Administration 5% Housing and community development 3% Parks and Recreation 2% Sewerage 3% Solid Waste 1% Public welfare 3% Police protection 5% Health 3% Corrections 2% Highways 4% Hospitals 5% http://www.census.gov/prod/2009pubs/10statab/stlocgov.pdf
Structure of Taxes Regressive % of income paid in taxes as income Progressive % of income paid in taxes as income Proportional % of income paid in taxes is fixed as income changes
Structure of Taxes Regressive Sales tax, Social Security taxes Progressive U.S. federal income tax, estate taxes Proportional Flat tax, Medicare tax
Budget Lingo Balanced budget Revenues = Expenditures Budget deficit Revenues < Expenditures Budget surplus Revenues > Expenditures Government debt Sum of all deficits Sum of all surpluses
Deficits and Debt Government must borrow money when it runs a budget deficit Government borrows from Individuals Corporations Financial institutions Foreign entities or foreign governments
Fiscal Policy and Economic Goals National economic goals include Growth Stability Full employment Freedom Security Equity Efficiency Using government spending and taxation programs to achieve goals
What is the Goal? Taxes Deductions Spending Capital gains Tariffs Mortgage interest Student loan interest Charitable donations Social Security NASA Food stamps Defense Spending
Business Cycle Long Run Growth Trend Real GDP Expansion Recession Time
Price Level Aggregate Supply PL1 Aggregate Demand Real GDP YF Full Employment Level of Output
Expansionary Fiscal Policy Response to a recession (economy is operating below full employment) Seeks to stimulate production (and consumption) Directly (expenditures ) Indirectly (taxes to encourage household spending or investment spending)
Fiscal Responses to 2008 Recession Emergency Economic Stabilization Act of 2008 American Recovery and Reinvestment Act of 2009 Established the Troubled Assets Relief Program (TARP) New Renewable energy and weatherize buildings Making Work Pay tax credit and Child Tax Credit infrastructure (roads, bridges, and mass transit) Fund Pell Grants
Contractionary fiscal policy Response to inflation (economy is operating above full employment and prices are rising) Seeks to reduce production (and consumption) Directly (expenditures ) Indirectly (taxes to discourage household or investment spending) Politically difficult
Measuring Fiscal Policys Effects Effects are not limited to the initial dollar value of the change in policy The eventual effects may be larger or smaller, depending on: Multiplier effect Crowding-out effect
Multiplier Effect Spending and tax policies create a chain reaction in the economy as people spend new income Many factors complicate the multiplier Taxes International trade Differing consumption patterns among various segments of the population
Crowding Out Investment or consumption spending that is lost because government borrowing drives up interest rates Government is entering the same market for funds as investors
Two Types of Fiscal Policy Discretionary fiscal policy Policymakers change tax policies or spending programs in response to fluctuations in the business cycle (at their discretion) Automatic stabilizers Implemented without any deliberate action from policymakers Found in the tax system and spending programs
Automatic Stabilizers Tax System Taxes are linked to economic activity Progressive income tax rates (individual and corporate) Payroll taxes Sales and excise taxes Recessions automatic tax cut Expansion automatic tax increase
Automatic Stabilizers Spending Government spending responds to the business cycle Unemployment insurance benefits Welfare benefits School lunch programs Other income-support programs Recessions more spending Expansion less spending
Challenges Related to Fiscal Policy Political factors Time lags Time required to create and pass legislation Time required to implement legislation Supply side impacts Forecasting difficulties Monetary policies may reinforce or offset fiscal policies
