PSCI 1500: Introduction to Economics

Government Revenue & Expenditure:

The Fiscal System

MACROECONOMIC POLICIES

Overview of Macroeconomics PolicyFiscal Policy

Influencing the levels of aggregate output and employment or prices through changes in federal government purchases, transfer payments, and/or taxes.

Monetary Policy Influencing levels of aggregate output and employment or prices through changes in interest rates and the money supply.

Categories of Government Expenditures

i. Government purchases of goods & servicesGovernment spending on new goods and services

Public good – good/service provided to society. Quasi public good - government-provided good

that could be sold in a private market.ii. Transfer Payments

Money from the government for which no direct work is required in return.

iii. OthersInterest paid on borrowed funds; grants-in-aid to state and local governments

OVERVIEW OF GOVERNMENT EXPENDITURES & REVENUES

OVERVIEW OF GOVERNMENT EXPENDITURES & REVENUES

GOVERNMENT EXPENDITUREGOVERNMENT OPERATING

EXPENDITURE

GOVERNMENT DEVELOPMENT EXPENDITURE

General administration

Social services Economic services

Defense and security

OVERVIEW OF GOVERNMENT EXPENDITURES & REVENUES

Example : US Case

Example : US Case

OVERVIEW OF GOVERNMENT EXPENDITURES & REVENUES

OVERVIEW OF GOVERNMENT EXPENDITURES & REVENUES

Tax refers to financial charge or levy imposed on the eligible taxpayers

Important feature of tax system is the percentage of the tax burden relative to income or consumption

Each term/type describe the way the rate progresses from low to high, vice versa, or proportionally.

Each term describe different distribution effect of tax on the income or consumption.

TAX AS THE MAIN GOVERNMENT SOURCE OF REVENUE

TERMS OF TAX STRUCTURE

1. Progressive Tax Tax reflecting a direct relationship between the

percentage of income taxed and the size of the income.

As income increases, so too does the rate at which that income is taxed, and vice versa.

TAX AS THE MAIN GOVERNMENT SOURCE OF REVENUE

2. Proportional Tax (flat tax) Tax equal to the same percentage of income

regardless of the size of the income. As income increases or decreases, the rate at

which that income is taxed remains constant.

3. Regressive Tax Tax reflecting an inverse relationship between the

percentage of income taxes and the size of the income.

As income increases, the rate at which that income is taxed decreases, and vice versa.

TAX AS THE MAIN GOVERNMENT SOURCE OF REVENUE

FISCAL POLICY

Fiscal Policy

Influencing the levels of aggregate output and employment or prices through changes in government purchases, transfer payments, and/or taxes.

TYPES OF FISCAL POLICY BY MECHANISM

EXPANSIONARY FISCAL POLICY

CONTRACTIONARY FISCAL POLICY

Two ways of managing the fiscal policy:

1. Automatic Fiscal Policy• Also called automatic stabilization.• Changes in government expenditures and/or taxes that occur automatically as the level of economic activity changes to control unemployment or demand-pull inflation.

2. Discretionary Fiscal Policy• Deliberate changes in government expenditures and/or taxes to control unemployment or demand-pull inflation.

FISCAL POLICY

FISCAL POLICY

Discretionary Fiscal Policy

Expansionary:

1) Unemployment due to a decline in spending - resolved by any or all of the following tools:• Increase government purchases of goods & services• Increase transfer payments• Decrease taxes

FISCAL POLICY

Discretionary Fiscal Policy

Contractionary:

1) Demand-pull inflation from too much spending -resolved by any or all of the following tools:• Decrease government purchases of good & services• Decrease transfer payments• Increase taxes

SUMMARY OF FISCAL POLICY

In what phase of a business cycle would contractionary fiscal policy be appropriate? Describe how it will take effect during the

phase.

REVIEW

TYPES OF GOVERNMENT BUDGETS

1. BALANCED BUDGET

The government’s total expenditure is equal to its total revenue.

2. SURPLUS BUDGET

 

The government’s total expenditure is less than its total revenue.

3. DEFICIT BUDGET

 

The government’s total expenditure is more than its total revenue.

CONTRACTIONARY POLICY

• Contractionary policy is designed to enlarge the budget surplus or reduce budget deficit.

• This is to dampen aggregate spending thus aid in managing demand-pull inflation.

EXPANSIONARY POLICY

• Expansionary policy is designed to enlarge the budget deficit or reduce budget surplus.

• This will increase the aggregate spending and help to reverse a recession.

BUDGET & FISCAL POLICY RELATIONSHIP

National Debt

• Government, public or sovereign debt

•Money (credit) owed by a central government.

Financing the National Debt

• Issued by government in return for funds lent to it.

• Largest portion of the national debt is held by private investors, and the rest is owned by the central banks, government agencies, and trusts.

NATIONAL DEBT

SOURCES OF NATIONAL DEBT

NATIONAL DEBT

INTERNAL SOURCES

EXTERNAL SOURCES

SOURCES FOR NATIONAL DEBT

• Borrowing from citizen• Borrowing from financial institutions• Loans from the central bank• Loans from commercial bank

• International money market• Currency loans from foreign government• Loans from international financial

institutions

INTERNAL SOURCES

EXTERNAL SOURCES

Issues in assessing the National Debt

Debt ServiceCost to maintain debt, measured in interest.

Crowding OutOccurs when borrowing by the government reduces borrowing by households and businesses.

NATIONAL DEBT

REVIEW

Identify the budget type most likely invoked during:

Recession -Inflation -

Explain the relationship between the budget type and its fiscal policy.

• Budget deficit indicate expansionary policy - increase government expenditure, transfer payment and/or decrease the tax.

• Budget surplus indicate contractionary policy - decrease government expenditure, transfer payment and/or increase the tax.

budget deficit (enlarge deficit/ reduce surplus).budget surplus (enlarge surplus/ reduce deficit).