Fiscal Policy Unit How the Federal Government Regulates the Economy Essential Question: How Does the Government Formulate Policies to Keep the Economy Healthy? What are two ways the government monitors our economic growth ? Monetary Policy Fiscal Policy Congress Ben Bernanke President Chair of the Federal Reserve So…….what is Fiscal Policy? Fiscal Policy is the use of the government of its powers to tax and spend for the purpose of regulating the economy Federal Income Tax Must be Filed by April 15 Why do we need Fiscal Policy? Humphrey Hawkins Act mandated that the Government must: – Promote economic growth – Promote full employment – Keep prices stable Classical Economic Theory: Pre- Great Depression – Economy was like boat on the water: boat rides the waves up and down – Leave it alone; keep government out of business – Left to economy’s natural laws of supply and demand the ship will right itself – Problem: metaphor was wrong ! Keynesian Theory: FDR’s Partial Solution to Great Depression John Maynard Keynes said that economy was more like an elevator Elevator was stuck Keynes recommended government intervention Increase spending to stimulate demand; put people back to work Who is John Maynard Keynes ? Government advisor, teacher, journalist, globalist Revolutionized economic theory The General Theory on Employment, Interest & Money Influenced wartime and post- war U.S. economic policy New Deal Economics/ Demand Side Economics/Keynesian Economics Why Does Deficit Spending Work? The Multiplier Effect or “Marginal Propensity to Consume” Why does Deficit Spending Work? So why do we spend more than we take in ? The Multiplier Effect ! Economic fluctuations feed upon themselves…expansion creates further expansion Also called “Marginal Propensity to Consume” in economic circles But…. You can have a Negative Multiplier Effect too ! Called “Murphy’s Law” by Mrs. McCarthy Recession can creates further recession. How does the government implement fiscal policy ? Discretionary Policies : The deliberate manipulation of taxes and government spending by Congress – Increase /decrease taxes by law – Increase/decrease spending by law ( $700 Billion bailout is an example of this) Automatic Stabilizers (non-discretionary) – Unemployment Compensation – Progressive Income Taxes Two Types of Discretionary Policies: Expansionary policy – jumpstart the economy – stimulate demand How would you do it? – increase gov’t spending – decrease taxes When used? “Grow the economy” – during a recession Second Type of Discretionary Policy Contractionary Policy – “cool” the economy – slow down demand What kind of policies? – decrease spending – increase taxes People will have less When used? money to spend – inflationary times What is “mandatory spending”? Automatic Stabilizers: Help “Self-Regulate” the Economy Federal Income Tax – Progressive – Tax increases automatically with change in income level Unemployment Insurance – Automatically given to unemployed – Limit: 26 weeks – Sept II exemption HR 3090 Why should we spend money we don’t have? Debts we incur today to fight a war will keep our children free in the future Interest rate on U.S. savings bonds,Treasuries, etc. go back to Americans –for the most part Avoid negative multiplier effect ! It is part of our social obligation to take care of those less fortunate (Medicare, Medicaid, Head Start ,etc Why should we avoid deficit spending? Our children and grandchildren will be saddled with debts we incur today ( we are mortgaging our children’s future) It fuels inflation ( more $$$ in the economy) National Security Risk: a significant amount of our national debt is owed to sovereign countries Deficit Spending increases our national debt What is the debt ? National debt is the accumulated deficits that add up over Click above to see the debt today ! the years Today’s Debt: $14.3 Trillion The U.S. debt of $14.3 Trillion was 97.3 % of 2010 annualized GDP ($14.6 trillion ) (Data is true as of 3/31//11) Debt as a percentage of GDP has risen sharply over last three years Historic Look at the Debt Debt as Percentage of GDP Projected (2012) Debt as a Percentage of GDP WHO DOES THE U.S OWE MONEY TO ? China and Japan own nearly a trillion and a half dollars of US debt (called “sovereign debt”) between the two of them. The government also owes money to intra-governmental agencies such as Social Security Trust. This also must be paid back. Another way to look at it ! Not only does the U.S. Government have to pay off the debt, but must pay interest on all that money it borrows……further increasing the debt ! 25 cents out of every federal revenue dollar goes to paying off the interest on our national debt !!!!!! Another sobering statistic! Why is Regulating the Economy a Tough Balancing Act ? What happens in an Election Year to a candidate who says that we need to raise taxes? Typically, in an election year, politicians let Monetary policy regulate the economy Why the Gov’t has a Dilemma ! ! Policies that are put I in place to bring n f down inflation will l also, paradoxically, a increase t unemployment i The Phillips Curve o n represents the inverse relationship Economics USA : Fiscal Policy L.B.J’s “Great Society – State of the Union - 1965 Increased Gov’t Spending – War on Poverty – Medicare – Medicaid – NEA PBS TV & Radio Reduced Taxes Best example of fiscal policy Economics USA: Fiscal Policy Employment Act of 1946 Promoted (not guarantee) full employment Committed the U.S. gov’t to initiate policies and programs that: Promote economic growth Maintain price stability (no inflation) Established the Council of Economic Advisors President must report on economic health of nation to congress yearly There are only two certainties in life….. anyone know what they are ? The “art” of taxation….. In 1665, King Louis XIV’s finance minister, Jean Baptiste Colbert, said that the art of taxation consisted of so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing. What do you think he meant? Jean Baptiste Colbert Everything About Taxes You Always Wanted to Know ! Why Are Taxes Necessary? What is a Fair Tax? Who Should Pay Taxes? What is the Flat Tax Proposal? What is FICA? Why Pay Taxes? Someone has to defend country Someone has to mail your grandparents social security checks Someone has to keep the Yellowstone National Park clean Someone has to keep the interstate highways in good shape How many kinds of Taxes are there ? Federal Income Tax (called Withholding Tax) FICA (Social Security Taxes Or Payroll Taxes) Capital Gains Taxes ( tax on gains or profits) Corporate Income Taxes Excise Taxes (“sin taxes” on alcohol, tobacco) Estate Taxes ( “death taxes”) Tax Structures Regressive Taxes – the effective tax rate actually decreases as a person’s income goes up ( ex. RI sales tax) Progressive Taxes – effective rate increases as the person’s income goes up ( ex. Federal Income Tax) Proportional Taxes – effective tax rate is the same regardless of income (ex. Proposed 17% flat tax) and Medicare tax of 1.45 %) Let’s Look at RI State Tax Is it a Fair Tax ? What tax structure does it fit ? Joel vs. Toby’s tax experience Joel paid $2,000 in sales tax last year in RI $2000 Sales Tax $10,000 Income = 20 % of his income Toby also paid $2,000 in sales tax last year in RI $2,000 Sales Tax $100,000 Income = only 2 % of his income Not all rates are the same ! Nominal tax tax Effective rate is the rate takes into legal tax rate account the percentage of RI’s nominal your income that sales tax rate you actually pay is 7 % in taxes Are the tax rates fair to all ??? RI Sales Tax: 7% Why does RI sales tax take a larger bite out of a poor person’s income than a rich person’s ? Let’s look at Joel and Toby’s experience again Joel vs. Toby’s tax experience Joel paid $2,000 in sales tax last year in RI $2000 Sales Tax $10,000 Income = 20 % of his income *********************************************************** Toby also paid $2,000 in sales tax last year in RI $2,000 Sales Tax $100,000 Income = only 2 % of his income What is a Good Tax? It should be Fair – i.e. proportion to Income It should be Clear and Certain Who – I.e. simple to understand came up It should be Simple & Efficient – should be hard to evade with this – should not cost more to idea ???? collect than its yield) It should be Flexible – should adjust to economic Adam Smith conditions Father of Economics So how many kinds of taxes are there ? Regressive Taxes – the effective tax rate actually decreases as a person’s income goes up ( ex. RI sales tax) Progressive Taxes – effective rate increases as the person’s income goes up ( ex. Federal Income Tax) Proportional Taxes – effective tax rate is the same regardless of income (ex. Proposed 17% flat tax) and Medicare tax of 1.45 %) What is Engel’s Law? According to Engel’s Law proportional and regressive taxes are inherently unfair ! Why? They are more of a burden to the poor than the rich because they represent a greater percent of the income of a poor person than a rich person. “Incidence of Tax” Who can least afford to pay taxes? What products present the greatest tax Gasoline & Food have a high “incidence” of tax. burden? Products with inelastic demand have the most “incidence of tax” How Should Taxes be Assessed or Levied ?? Benefits Received Ability to Pay Those that benefit Everyone receives from service should benefit, however, pay only those that can Bridge afford to pay Highways should pay taxes What about parks ? Is this equitable? Use of Libraries ? Is this fair? just ? Garbage Collection ? Has anyone thought of a better way to structure taxes? Are there any fair alternatives ??? Some Senators and Representatives are advocating a “flat tax.” Many European countries have adopted it (Estonia) “Armey- Shelby Flat Tax “Proposal? Freedom and Fairness Restoration Act Flat Tax of 17% on all Americans No deductions (except for children) Family of four would have to earn $36,800 before flat tax applied Richard Shelby Who pays for the cost of running the government ???? Budgets Three levels: – Federal (U.S.) – State (RI) – Local (Barrington) All levels must develop budgets with taxes and spending in mind Budget Talk: Surplus Budget: when revenues exceed expenditures Deficit Budget: when expenditures exceed revenues Fiscal year: Oct 1- Sept 30 Operating Budgets Capital Budgets Question ? Rhode Island has allocated $17 million for the relocation of Route 195. What type of state budget does this expense fit into and why ? If the RI State House put in a purchase order for Post-It notes, new pencils, mops, & light bulbs, what type of budget would these items fit ? Budget: FY 2007 ( Oct 2006-Sept 2007) FY 2007 budget: $ 2.7 Trillion Fiscal Year 2008 (Oct 2007- Sept 2008) $ 2.9 Budget Trillion 2009 Budget (Oct 2008- Sept 2009) A whopping $ 3.1 Trillion ! 2010 Obama Budget (Oct 09 – Sept 2010) $3.5 trillion 2011 Budget ( Oct 1, 2010 – Sept 30, 2011) $3.82 Trillion 2012 Budget (October 1, 2011- Sept 30, 2012 $ 3.7 Trillion (proposed) What happens when you spend more than you take in ? FY 1999: $238 Billion Surplus (Clinton) FY 2003: $138 Billion deficit FY 2004: $412 Billion deficit FY 2005: $317 Billion deficit FY 2006 : $248 Billion deficit FY 2007: $162 Billion deficit FY 2008 : $410 Billion deficit FY 2009: $1.4 Trillion deficit ! ! ! FY2010 : $1.29 Trillion Deficit FY 2011: $ 1.5 -1.6 Trillion Deficit Projected Budget Deficits to 2021 ! One cartoonist view of the impact of the Obama stimulus package Bush (II) era recession due to dot.com bust (saturated demand) Carter era Steady deficits due to oil decrease crisis, low Clinton era in deficit productivity surplus: in early (new workers ) Dot.com boom Reagan era-deficit Clinton and and --partial result of years productivity environmental 750 billion tax cut issues Past Budget Deficits and Surpluses Federal Deficits and Surplus! Surplus How do budgets get so “bloated” ? “Earmarks”- many Congressional representatives hold major revenue bills hostage with “earmarks” for their home districts Alaska's famous "bridge to “Pork Barrel” nowhere" The project, which would have cost close to $400 million Legislation dollars to connect a tourist island to an airport, became famous for its appearance as “pork” Has Anyone Tried to Stop the Madness ??? Historic Efforts to Cut the Deficit Gramm-Rudman-Hollings Act – Limit deficit to $ 100 billion in 1990 – Limit deficit to $ $64 billion in 1991 – Limit deficit to $28 billion in 1992 – Balance the budget by 1993 Balanced Budget Amendment - 1995 – Required federal budgets to be balanced before they became law – Failed by one vote in Senate Who Prepares the Budget ? OMB: Office of Management and Budget in Exec Office prepares the Budget Congress has final say, however. Budget that gets passed is often a very different one that the President proposed President Barack Obama with OMB Director, Peter Orszag, going over the 3.5 Trillion dollar budget for FY 2010 FAQ’s : Federal Budget Q. What is largest single federal expenditure? A. Entitlement programs (Social Security Medicare, Medicaid) Q. What is largest single source of revenue? A. Federal Income Tax What does the CBO do ? 2010 Receipts (Estimates) FY 2010 Budget Breakdown Mandatory spending: $2.184 trillion (+15.6%) Biggest components: $695 billion (+4.9%) - Social Security $453 billion (+6.6%) - Medicare $290 billion (+12.0%) - Medicaid $ 11 billion (+275%) - Potential disaster costs $571 billion (-15.2%) - Other mandatory programs $164 billion (+18.0%) - Interest on National Debt •Discretionary spending: $1.368 trillion (+13.1%) $663.7 billion (+12.7%) - Department of Defense (including Overseas Contingency Operations) $78.7 billion (-1.7%) - Department of Health and Human Services $72.5 billion (+2.8%) - Department of Transportation $52.5 billion (+10.3%) - Department of Veterans Affairs $51.7 billion (+40.9%) - Department of State and Other International Programs $47.5 billion (+18.5%) - Department of Housing and Urban Development $46.7 billion (+12.8%) - Department of Education $42.7 billion (+1.2%) - Department of Homeland Security $26.3 billion (-0.4%) - Department of Energy $26.0 billion (+8.8%) - Department of Agriculture $23.9 billion (-6.3%) - Department of Justice $18.7 billion (+5.1%) - National Aeronautics and Space Administration $13.8 billion (+48.4%) - Department of Commerce $13.3 billion (+4.7%) - Department of Labor $13.3 billion (+4.7%) - Department of the Treasury $12.0 billion (+6.2%) - Department of the Interior $10.5 billion (+34.6%) - Environmental Protection Agency $9.7 billion (+10.2%) - Social Security Administration $7.0 billion (+1.4%) - National Science Foundation $5.1 billion (-3.8%) - Corps of Engineers $5.0 billion (+100%) - National Infrastructure Bank $1.1 billion (+22.2%) - Corporation for National and Community Service $0.7 billion (0.0%) - Small Business Administration $0.6 billion (-14.3%) - General Services Administration $19.8 billion (+3.7%) - Other Agencies $105 billion - Other FAQ’s: State Budgets Q. What is the largest source of revenue for the state? A. Sales Tax Q. What is the largest expenditure on the state level A. Education ( Social Security runs a close 2nd) RI State House FAQ’S: Local Level Q. What is the largest source of revenue on local level? A. Property Taxes What is the largest expenditure on the local level? Barrington Town Hall A. School Budget WHAT IS OUR BIGGEST FISCAL CHALLENGE AHEAD ? These graphs say it all ! Baby Boomers ! 78 million Baby boomers will very soon need: – Social Security payments – Medicare coverage Medicare will pay out more this year than it takes in ! Social Security will pay out more than it takes in 2017 How will we “Save Social Security? How are Social Security Benefits calculated? Retirement benefit calculations are based on your average earnings during a lifetime of work under the Social Security system. For most current and future retirees, the SSA will average your 35 highest years of earnings. When can I start receiving full benefits ? 1937 or earlier age 65 1938 - 65 and 2 months 1939 - 65 and 4 months 1940 - 65 and 6 months 1941 - 65 and 8 months 1942 - 65 and 10 months 1943--1954 - 66 1955 - 66 and 2 months 1956 - 66 and 4 months 1957 - 66 and 6 months 1958 - 66 and 8 months 1959 - 66 and 10 months 1960 and later - 67 Other Facts About Social Security You pay 6.2 % of your income - up to $106,800 Your employer pays 6.2% on your income - up to $106,800 You can collect earlier (62) at a lower benefit ($) You can choose to delay retirement (>67) and get higher benefits ($) http://www.ssa.gov/retire2/delayret.htm You must work for 40 quarters/credits (about 10 years) to be eligible for Social Security You must earn $ 1,120 to earn one S.S. “credit” One way of Saving Social Security ! How will you save it ?