sg31 - Chapter 15 FISCAL POLICY* Key Concepts The Federal...

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219 15 FISCAL POLICY* Key Concepts ± The Federal Budget The federal budget is an annual statement of the gov- ernment’s expenditures and tax revenues. Using the federal budget to achieve macroeconomic objectives such as full employment, sustained economic growth, and price level stability is fiscal policy . The President proposes a budget to Congress, Congress passes budget acts, and the President vetoes or signs the acts. The Employment Act of 1946 commits the gov- ernment to strive for full employment. The Council of Economic Advisers is a group of economists who monitor the economy and keep the President and the public informed about the current state of the economy and the best available forecasts of where it is heading. Tax revenues are received from four sources: per- sonal income taxes, social security taxes, corporate income taxes, and indirect taxes. The largest source of revenue is the personal income tax. Expenditures are classified as transfer payments, purchases of goods and services, and interest pay- ments on the debt. The largest expenditure item is transfer payments. The budget balance equals tax revenues minus expendi- tures. A budget surplus occurs if tax revenues exceed expenditures; a budget deficit occurs if tax reve- nues are less than expenditures; and a balanced budget occurs if tax revenues equal expenditures. * This is Chapter 31 in Economics . The U.S. government had a budget deficit from 1980 to 1997. Between 1998 to 2001 the govern- ment had a budget surplus but by 2002 the budget was back in deficit. Most nations have budget deficits. Government debt is the total amount that the government has borrowed. As a percentage of GDP, the debt declined after World War II until 1974, increased until the mid 1990s, fell until 2002 and has risen since then. ± The Supply Side: Employment and Potential GDP The effects of fiscal policy on employment, potential GDP, and aggregate supply are called supply-side ef- fects . The labor market determines the quantity of labor employed and the production function shows how much real GDP is produced by this amount of employment. When the labor market is in equilibrium, the amount of GDP produced is potential GDP. An income tax decreases the supply of labor, which increases the before-tax wage rate and decreases the after-tax wage rate, thereby creating a tax wedge be- tween the (higher) before-tax wage rate and the (lower) after-tax wage rate. Taxes on consumption expenditure also add to the overall tax wedge because they raise the prices of goods and services and so lower the real wage rate. The U.S. tax wedge is relatively small. An increase in the tax rate decreases the supply of labor, so it decreases equilibrium employment and potential GDP. The
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This note was uploaded on 05/13/2010 for the course ECON 323 taught by Professor Jakes during the Spring '10 term at Alcorn State.

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sg31 - Chapter 15 FISCAL POLICY* Key Concepts The Federal...

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