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Class 25 Outline for Taxes and Government Deficits

Class 25 Outline for Taxes and Government Deficits - Class...

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Class 25 Discussion Outline for Taxes and Government Deficits How big should the government be? What fraction of gdp should be determined by Gov’t economic activity? What are the proper functions of Government? What are the factors that determine that fraction? These lie at the center of the current debt and deficit crisis temporarily averted Aug 2, 2011 by the debt ceiling compromise. 1. G = Government Expenditures. Expenditures are of four main types: a. Operational expenses (discretionary spending) in gov’t departments like defense. b. Short term counter cyclical expenditures—like unemployment insurance & AFDC spending c. Entitlements: Medicare, Medicaid and Social Security—major problem unresolved—to be decided! d. Interest on the debt 2. T = Current Tax Collections: T = rate * Base ( T = t*Y, for t = average tax rate) a. t is the “implied” average tax rate; b. Marginal rates are specified in the tax code. 3. D = Deficit = (G – T) = B, where B = new Treasury Issues of Bonds (i.e., D = B) a. 3) can be usefully rewritten as G = T + B a.i. G = present value of expenditures a.ii. T = present value of present revenue collection a.iii. B = present value of future revenue collection a.iv. Ricardian Equivalence a.iv.1. Reducing T now means higher T later and it will not have as big an impact on demand as believed. a.v. Only planned budget deficits are known in advance a.vi. Actual deficits are not controllable. b. The implication of i through vi is: b.i. in present value terms the Government budget is always balanced
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b.ii. Tax cuts are a euphemistic way of saying tax deferral b.iii. The true measure of taxes is G. To get more T , act to have more G 4. Hauser’s Law & the history of tax collections as a % of gdp 5. Marginal v. Average Tax rates Why all the rancor and heated political discussion concerning government debt? Basically, government debt competes for savings that could be otherwise used to finance private investment! This is the issue: on margin, which sector can best create sustainable growth in the economy: the government or the private sector? 6. Implications for future fiscal policy options of the increasing magnitude of outstanding debt created by the current stimulus “package”. a. QE & QE2 “Quantitative Easing” Effect of FED purchases on price and yields? a.i. Fed action is attempting to keep interest rates low to stimulate investment. This helps borrowers but is not helpful for savers. b. “Flight to Quality” and Returns on alternative assets? b.i. During recessions, which tend to increase the risk of private economic activity, movement into Treasuries raises the cost of private capital which creates a drag on private investment that can lead to economic expansion. c. Effect of FED sales when economy starts to expand? c.i. Once recovery is beginning, too much growth can lead to inflation which requires the Fed to raise rates to keep the economy from creating d.
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Class 25 Outline for Taxes and Government Deficits - Class...

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