Fiscal PolicyFiscal Policy

How are taxes collectedHow are taxes collected• ““Pay-as-you-earn”Pay-as-you-earn”– Taxable income: income on which you can be Taxable income: income on which you can be

taxedtaxed• Personal exemptions and deductions subtracted from Personal exemptions and deductions subtracted from

gross incomegross income– Withholding: taking money from your pay checkWithholding: taking money from your pay check

• Paying TaxesPaying Taxes– Tax return: 1040 formTax return: 1040 form– W-2: form from employer showing taxable W-2: form from employer showing taxable

incomeincome

Types of Common Federal TaxesTypes of Common Federal Taxes• Federal income tax – progressive income tax based on tax bracketsFederal income tax – progressive income tax based on tax brackets• Corporate income tax – subject to numerous deductionsCorporate income tax – subject to numerous deductions• Federal Insurance Contributions Act (FICA)Federal Insurance Contributions Act (FICA)

– Requires withholding to fund Social Security and MedicareRequires withholding to fund Social Security and Medicare

• Unemployment taxes – collected from employersUnemployment taxes – collected from employers

The Fiscal The Fiscal CliffCliff

Other types of TaxesOther types of Taxes• Excise tax –Excise tax – Consumer tax on a specific kind of merchandise, such Consumer tax on a specific kind of merchandise, such

as tobacco.as tobacco.• Tariff –Tariff – Tax levied on imports to help protect the nation’s Tax levied on imports to help protect the nation’s

industries, labor, or farmers from foreign competition.industries, labor, or farmers from foreign competition.• Sales tax –Sales tax – General tax on sales transactions, sometimes General tax on sales transactions, sometimes

exempting food and drugs.exempting food and drugs.• Estate Tax – Estate Tax – tax on the total value of money and property when tax on the total value of money and property when

someone diessomeone dies• Value-added tax (VAT) –Value-added tax (VAT) – on increased value of the product at on increased value of the product at

each stage of production and distribution rather than just at the each stage of production and distribution rather than just at the point of sale.point of sale.

• Tax Incentive Tax Incentive – used to encourage or discourage behavior– used to encourage or discourage behavior• Tax expenditure –Tax expenditure – Loss of tax revenue due to Federal laws that Loss of tax revenue due to Federal laws that

provide special tax incentives or benefits to individuals or provide special tax incentives or benefits to individuals or businesses.businesses.

Government SpendingGovernment Spending• Deficit vs. DebtDeficit vs. Debt

– Keynesian economics -Keynesian economics - Economic theory stating that government spending Economic theory stating that government spending should increase during business slumps and be curbed during booms.should increase during business slumps and be curbed during booms.• The Federal StimulusThe Federal Stimulus

– Laissez-faire economics –Laissez-faire economics – Theory that opposes governmental interference Theory that opposes governmental interference in economic affairs beyond what is necessary to protect life and property.in economic affairs beyond what is necessary to protect life and property.• Balanced budgetBalanced budget

• Distributive policy vs. Redistributive policy Distributive policy vs. Redistributive policy • Types of SpendingTypes of Spending

– Direct benefit payments – entitlements such as social securityDirect benefit payments – entitlements such as social security– Discretionary spending Discretionary spending

• government programs: environment, transportation, assistance programsgovernment programs: environment, transportation, assistance programs• Defense spendingDefense spending

The Federal Reserve System’s 12 Federal Reserve Districts make up the central The Federal Reserve System’s 12 Federal Reserve Districts make up the central banking system of the United Statesbanking system of the United States

• All Nationally charter banks required to joinAll Nationally charter banks required to join• State-chartered banks can join voluntarilyState-chartered banks can join voluntarily

• The Board of Governors The Board of Governors 1) fixes the discount rate 1) fixes the discount rate 2) raises or lowers the reserve requirement 2) raises or lowers the reserve requirement 3) puts money into the economy through open market operations3) puts money into the economy through open market operations

• Federal Open Market CommitteeFederal Open Market Committee–Makes key decisions interest rates and growth of money supplyMakes key decisions interest rates and growth of money supply

• Board of GovernorsBoard of Governors– Appointed by the Appointed by the

president – 14 year term, president – 14 year term, staggeredstaggered

– Chairman: 4 year term, Chairman: 4 year term, renewablerenewable

Ben Bernanke, Chairman of the Federal Reserve

Functions of the Federal ReserveFunctions of the Federal ReserveGovernment ServiceGovernment Service•Government’s Banker•Issues Currency

Regulating BanksRegulating Banks•Reserves•Bank examinations

Regulating the Money SupplyRegulating the Money Supply•Factors affecting demand for money

1. Cash needed on hand2. Interest rates 3. Price levels in the economy4. General level of income

Monetary Policy ToolsMonetary Policy ToolsMoney CreationMoney Creation•Money created through normal Money created through normal operationsoperations•Money Multiplier formulaMoney Multiplier formula

– Initial Deposit x 1/RRRInitial Deposit x 1/RRR

Reserve RequirementsReserve Requirements•Reduction of the RRR allows more Reduction of the RRR allows more loans, increase supplyloans, increase supply•Increase in RRR requires higher Increase in RRR requires higher reserves, decreases supplyreserves, decreases supply

Setting ratesSetting rates•Discount (Fed to Bank)Discount (Fed to Bank)•Federal funds rate (bank to bank)Federal funds rate (bank to bank)•Prime rate (Banks to top customers)Prime rate (Banks to top customers)Open Market OperationsOpen Market Operations•Buying government securities Buying government securities increases the money supplyincreases the money supply•Selling government securities Selling government securities decreases the money supplydecreases the money supply