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.