Chapter Ten:
Fiscal Policy
The Role of Government Spending and Taxes
Table 10.1: An Increase in Government Spending
Ag
gre
gat
e D
eman
d a
nd
Ou
tpu
t
Income (Y)
45°
400 800
400
800
160
80
E0 (Unemployment Equilibrium)
Full EmploymentAD1 (G = 80)
AD0 (G = 0)
Y*
E1
Full Employment Equilibrium
Figure 10.1: Increased Government Spending
Output (Y) Income (Y)
Spending (AD)
consumption (C)
Banks and Financial System
Government
Production generates income
to households
Savings
IntendedInvestment
Net T
axes
Gover
nmen
t Spe
ndin
g
Figure 10.2: A Macroeconomic Model with Government Spending and Taxes
The Federal Budget
Personal income taxes
(30%)
Corporate taxes (5%)
Social insurance and retirement taxes (23%)
Excise, estate, and other taxes
(6%)
Borrowing to cover deficit
(36%)
Figure 10.3a: United States Government Source of Funds and Outlays, Fiscal 2011
Social security, Medicare
(33%)
National defense, veterans,
foreign affairs (24%)
Income security, education, social
services (20%)
Health (10%)
Science, natural resources,
transportation (5%)
Justice, government administration (2%)
Interest on debt (6%)
Figure 10.3b
Figure 10.4: Federal Surplus of Deficit as a Percent of GDP
Per
cen
t o
f G
DP
Outlays
Receipts
Surplus or Deficit
Figure 10.5: Federal Outlays, Receipts, and Surplus/Deficit, as a Percent of GDP, 1980-2011
Source: Economic Report of the President 2012, Table b-79.
Policy Issues
Crowding out
Figure 10.6: Crowding Out in the Loanable Funds Market
Ag
gre
gat
e d
eman
d a
nd
ou
tpu
t
AD1 (decrease in t)
AD0 (original t)
45°
E1
E0
Y0 Income (Y)Y1
Slope = mpc(1 t)
Figure 10.7: A Reduction in the Proportional Tax Rate
Table 10.2: Different Multiplier Effects
Tax Cuts Multiplier
Nonrefundable Lump-Sum Tax Rebate 1.02
Refundable Lump-Sum Tax Rebate 1.26
Temporary Tax Cuts
Payroll Tax Holiday 1.29
Across the Board Tax Cut 1.03
Accelerated Depreciation 0.27
Permanent Tax Cuts
Extend Alternative Minimum Tax Patch 0.48
Make Bush Income Tax Cuts Permanent 0.29
Make Dividend and Capital Gains Tax Cuts Permanent
0.37
Cut Corporate Tax Rate 0.30
Spending Increases
Extend Unemployment Insurance Benefits 1.64
Temporarily Increase Food Stamps 1.73
Issue General Aid to State Governments 1.36
Increase Infrastructure Spending 1.59
Source: M. Zandi, “The Economic Impact of the American Recovery and Reinvestment Act,” Moody’s Economy.com, 2009.