Fiscal policy

1. Fiscal policy

2. What is fiscal policy? How do fiscal incomes and expenditures influence the economy? Tools of fiscal policy What is state budget?

3. What is fiscal policy? • Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply. These two policies are used in various combinations to direct a country's economic goals*. • Fiscal policy is the use of government revenue collection (mainly taxes) and expenditure (spending) to influence the economy. According to Keynesian economics, when the government changes the levels of taxation and government spending, it influences aggregate demand and the level of economic activity. Fiscal policy is often used to stabilize the economy over the course of the business cycle.

4. How it begun… • Before the Great Depression, which lasted from Sept. 4, 1929, to the late 1930s or early 1940s, the government's approach to the economy was laissez-faire. Following World War II, it was determined that the government had to take a proactive role in the economy to regulate unemployment, business cycles, inflation and the cost of money. • By using a mix of monetary and fiscal policies (depending on the political orientations and the philosophies of those in power at a particular time, one policy may dominate over another), governments can control economic phenomena.

5. How Fiscal Policy Works • Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known as Keynesian economics, this theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation (generally considered to be healthy when between 2-3%), increases employment and maintains a healthy value of money.

6. Expansive or Restrictive? There are two types of fiscal policy: • Expansive Fiscal policy – supports Aggregate Demand growth and therefore the growth of total output. • Restrictive Fiscal policy – is aimed to lessen the inflation rate by the means of limiting both the Aggregate demand and supply.

7. Expansionaryfiscal policy • Most widely-used, is expansionaryfiscal policy. It stimulates economic growth. It's most critical at the contraction phase of the business cycle. • How does it work? The government either spends more, cuts taxes, or does both if it can. The idea is to put more money into consumers' hands, so they spend more. That jump starts demand, which keeps businesses running and adds jobs. • Expansionary fiscal policy is usually impossible for governmentsthat are mandated to keep a balanced budget. If they haven't created a surplus during the boom times, they must cut spending to match lower tax revenue during a recession.That makes the contraction worse.

8. Contractionary fiscal policy • The second type, contractionary fiscal policy, is rarely used. That's because its goal is to slow economic growth. Why would you ever want to do that? One reason only, and that's to stamp out inflation. That's because the long-term impact of inflation can damage the standard of living as much as a recession. • The tools of contractionary fiscal policy are used in reverse. Taxes are increased, and spending is cut. You can imagine how wildly unpopular this is among voters. Thus, it's hardly ever used.

9. https://www.youtube.com/watch?v=4FNdUTN4cHY

10. What is fiscal policy? How do fiscal incomes and expenditures influence the economy? Tools of fiscal policy What is state budget?

11. Public expenditures Public Expenditures Government Expenditures (G) Transfers (Tr)

12. Influencing the economy..  Taxes Raisingtaxesmakepeopleadjusttheirbehaviour  Expenditures Governemntexpenditures are incomeforotheragentsanditchangestheirbehaviour Households, firms (economic agents) Households, firms (economic agents)

13. Private and Public sectors Consumption(C) Investment(I) Private sector T (Taxes) Tr (Transfers) Public Sector G Gov. Investment(IG) Gov. consumption(CG)

14. Macro-economical aspects of public expenditures • Public expenditures for goods and services (G) areimportant part of total incomes and expenses= an important part of AD. • Remember? AD (aggregate Demand)= Agg.Expenditure =C + IG + G + Xn • Trends of G influence employment and production in the economy. • G could work as multiplier in fiscal policy.

15. How does an increase in government purchases increase real GDP? • The Multiplier Effect in action ►The government increases its purchases. The aggregate expenditure function shifts up. ► Increased government purchases increase real GDP. ► Increased real GDP increases disposable income. ► Increased disposable income increases consumption (According to the marginal propensity to consume). ► Increased consumption increases real GDP (The cycle continues).

16. Marginal Propensity to Consume • How big is the multiplier effect? It depends on how much consumers respond to increases in income. • How can you use aditional income? You can spend it (use it as consumption) or you can save it. • Marginal propensity to consume (MPC): the fraction of extra income that households consume rather than save • E.g., if MPC = 0.8 and your income rises $100, thenyou spare $80 for consumption and you save remaining $ 20.

17. Multiplier theory by Keynes in-short • Each economic agent has marginal propensity to consume (MPC) and to save (MPS). Say, all people, including Mr. Smith, leave 25% of income in a bar (MPC=0,25), so MPS=0,75. • Let’s analyse what will happen to the money spent: • (1)Mr. Smith’s earns extra income 1000CZK (employer‘s expenditure) Mr. Smith spends 25% of 1000CZK (=250CZK) in a bar • (2)Mr. Black (bar-keeper) receives extra income of 250CZK Mr. Black spends 25% of 250CZK (=63 CZK) in a neighbour bar • (3)Mr. White (neighbour-bar-keeper) receives extra 63CZK Mr. White spends 25% of 63CZK (=16CZK) in another bar … • (10) Mr. Brown (a drug-store keeper) receives extra 0,005CZK for selling medicine against all the above gentlemen’s hangover. Total income generated: 1334,33 CZK

18. Multiplier theory by Keynes in-short • The formula: • In our example: • Multiplier 1,33 means, that 1000 CZK of money injection will lead to 1000*1,33=1330 CZK of generated income. • So in the same manner the government uses Multiplier Effect to lead to the growth of national income and further growth of consumption, support producers, etc.

19. Factors influencing growth of public expenditures • demographic factors: • shift from self-sufficiency on farm with large family to urban mutual dependence, • age structure changes, • etc. • militant affairs, • inflation trends (higher costs for goods and services), • technological changes (increased labour productivity), • production volumes growth – increase of incoming taxes, • increasing consumption, • political and social influences, • etc.

20. Who Does Fiscal Policy Affect? • Unfortunately, the effects of any fiscal policy are not the same for everyone. Depending on the political orientations and goals of the policymakers, a tax cut could affect only the middle class, which is typically the largest economic group. In times of economic decline and rising taxation, it is this same group that may have to pay more taxes than the wealthier upper class. • Similarly, when a government decides to adjust its spending, its policy may affect only a specific group of people. A decision to build a new bridge, for example, will give work and more income to hundreds of construction workers. A decision to spend money on building a new space shuttle, on the other hand, benefits only a small, specialized pool of experts, which would not do much to increase aggregate employment levels.

21. One of the biggest obstacles facing policymakers is deciding how much involvement the government should have in the economy. Indeed, there have been various degrees of interference by the government over the years. But for the most part, it is accepted that a degree of government involvement is necessary to sustain a vibrant economy, on which the economic well-being of the population depends.

22. https://www.youtube.com/watch?v=1qhJPqyJRo8

23. What is fiscal policy? How do fiscal incomes and expenditures influence the economy? Tools of fiscal policy What is state budget?

24. Fiscal Policy: Objectives and Tools •  Main objectives: • Balancing the budget (Pre-Great Depression) • Promoting full employment with price stability (Post Keynes and WWII) • Eliminating critical points of economic cycles • Economical growth promotion • General tools: • Discretionary Fiscal Policy • Automatic Stabilizers

25. 1. Tools of Discretionary Fiscal Policy • General tools: • Government purchases • Transfer payments • Taxes and Borrowing Given a price level, what changes will increase the level of real GDP? Other things being equal. • An increase in government purchases? • An increase in transfer payments?

26. 2. Automatic Stabilizers • Automatic Stabilizers stimulate AD during periods of recession and dampen AD during periods of expansion. • They do not require yearly government action to operate. • Examples of automatic stabilizers: • progressive income tax with its increasing marginal income tax rates, • unemployment insurance, • (social) transfers and (farm) subsidies, • welfare spending.

27. What is fiscal policy? How do fiscal incomes and expenditures influence the economy? Tools of fiscal policy What is state budget?

28. State (government) budget • A government budget is an annual financial statement presenting the government's proposed revenues and spending for a financial year that is often passed by the legislature, approved by the chief executive or president and presented by theFinance Minister to the nation. • The budget is also known as the Annual Financial Statement of the country. This document estimates the anticipated government revenues and government expenditures for the ensuing (current) financial year

29. System of public budgets • State budget, • Local budgets (regional, municipal), • Special centralized funds (i.e. in CR – National Property Fund, Land Fund, Environmental Fund etc.) State budget Localbudget 1 Localbudget 2 Localbudget N …

30. State budget • Passes in a Parliament as a law. • The fact of approval law implies confidence in government and its policy. • Budget is being approved for a Fiscal year (= calendar year) • USA: September – September, • Japan: March – March, • UK: April –April. • Any budget has 2 parts: • Revenue side • Expenditure side

31. Income side of the State budget • Direct taxes: • taxes on persons or property, • individual income tax, • employee social insurance tax, • corporate tax, • property tax, • Indirect taxes: • taxes on events or transactions, • employer payroll tax, • sales tax (including excise and value-added). • Other incomes for state budget: • Customs duties, • loans from abroad, • incomes from public offerings of state bonds

32. Principles of taxation • Fairness, efficiency, purpose. • The benefits principle is the idea that people should pay taxes based on the benefits they receive from government services. (I.e. gasoline tax: revenues from a gasoline tax are used to finance the highway system). • The ability-to-pay principle is the idea that taxes should be levied on a person according to how well that person can shoulder the burden: • Vertical equity (progressive and regressive system). • Horizontal equity (equal conditions).

33. State budget expenditures ►are the transfers and purchases of goods and services. Transfers = financial flows from state budget to individual subjects (firms and households). • Transfers to households: Social insurance, childern allowances, unemployment allowances etc. • Transfers to firms: Capital and non-capital subsidies. Govermental purchases of goods and services: capital and non-capital.

34. State budget: Result of the fiscal year • Deficit budget • Balanced budget • Surplus budget

35. Thank you for your attention