Introduction to Macroeconomics

1. Introduction to Macroeconomics Chapter 25 Taxes, Deficits, and the Debt

2. Taxes, Deficits & the Debt 1. Tax Structures 2. Discretionary vs Automatic Fiscal Policy 3. Fiscal Policy and the Budget 4. Deficits, Debt, and Fiscal Policy

3. 1. Tax Structure Types of Taxes - Average Tax Rates • Regressive Tax - average tax rate declines with increases in income • Porportional Tax - tax rate is a fixed percentage of income • Progressive Tax - average tax rate increases with increases in income

4. 1. Tax Structure Average Tax Rates

5. 1. Tax Structure Marginal Tax Rates Marginal Tax Rate - tax rate that applies to each additional dollar of income • Regressive Tax marginal tax rate < average tax rate • Proportional Tax marginal tax rate = average tax rate • Progressive Tax marginal tax rate > average tax rate

6. 1. Tax Structure Marginal Tax Rates - Income Tax

7. 2. Discretionary vs Automatic Policy Definitions • Discretionary Fiscal Policy • government spending or taxes that can be changed by policy makers • Automatic Fiscal Policy • desirable automatic changes in government spending or taxes that occur without policymakers taking action

8. 2. Discretionary vs Automatic Policy Automatic Stabilizers Automatic Stabilizers - Automatic fiscal policy changes that reduce the strength of upswings or downswings in the economy (i.e., are countercyclical) Examples: • income taxes • unemployment benefits

9. 2. Discretionary vs Automatic Policy Automatic Stabilizers

10. 3. Fiscal Policy and the Budget Definitions • Budget Surplus / Deficit • amount by which government tax revenues exceed / fall short of government spending • Debt • total accumulated value of budget surplus or deficit

11. 3. Fiscal Policy and the Budget Government Expenditures Share of GDP Source: Bureau of Economic Analysis, National Income and Product Accounts www.bea.doc.gov

12. 3. Fiscal Policy and the Budget Where Federal Spending Goes Defense Retirement Other Domestic International

13. 3. Fiscal Policy and the Budget Deficits Over Time

14. 3. Fiscal Policy and the Budget Deficits as a Percentage of GDP

15. 3. Fiscal Policy and the Budget Total U.S. Debt

16. 3. Fiscal Policy and the Budget Total U.S. Debt as a Percentage of GDP

17. 3. Fiscal Policy and the Budget External Debt as a Percentage of GDP External debt as a share of GDP for 195 countries Source: CIA World factbook

18. 3. Fiscal Policy and the Budget Budget Balancing Options Cyclically Balanced Budget • budget deficit during recessions • budget surplus during inflationary booms • budget balances over full business cycle • Benefits • allows use of discretionary policy • Costs • reduces budget discipline • deficits crows out investment

19. 3. Fiscal Policy and the Budget Budget Balancing Options Balanced Budget Amendment • Benefits • no crowding out of investment • less price inflation • Costs • inhibits use of discretionary policy • eliminates benefits of automatic stabilizers

20. 4. Deficits, Debt, and Fiscal Policy Deficits and Crowding Out Crowding Out - government deficit spending increases the real interest rate, which reduces (crowds out) investment spending • deficit financed by borrowing money (sell bonds to public) • price of bonds falls • interest rate rises • reduction in investment demand