Macroeconomics CH 11
In 2016, government expenditures were ____ , while government tax revenue was_____ trillion .
$3.866 trillion , $3.276 trillion
In 2014, the top 10% of income earners earned ____ of total income and paid ___ of federal income taxes.
47.21% of total income and paid 70.88% of federal income taxes.
Some economists argue for the use of fiscal policy to solve economic problems; some argue against it. Identify whether each argument in the following table is for the use of fiscal policy or against it. The economy is self-regulating. Fiscal policy is characterized by long lags. The crowding out effects of fiscal policy are large. The economy is not always self-regulating.
Against, against, against, for. The argument that "the economy is not always self-regulating" is for the use of fiscal policy. All remaining arguments are against the use of fiscal policy to solve economic problems. If the economy corrects itself quickly, or if there is crowding out, or if there are lags, then these are arguments against the use of fiscal policy. Complete crowding out occurs when a decrease in one or more components of private spending completely offsets the increase in government spending. Incomplete crowding out occurs when the decrease in one or more components of private spending only partially offsets the increase in government spending. If there were zero crowding out, then private sector spending would stay constant when government spending increased. There are five types of lags that could be associated with fiscal policy. The data lag involves the delay in receiving data about the state of the economy, which leads to policy makers not being aware of changes in the economy until after some time has passed. The wait-and-see lag is the lag that occurs when policy makers adopt a cautious stance and observe the economy for a while before implementing any policy changes. The legislative lag occurs due to the time that it takes to get new fiscal policy passed in Congress. The transmission lag is the time that it takes for fiscal policy to go into effect, and the effectiveness lag is the time it takes for the policy to cause changes in the economy. See Sections: "Crowding Out: Questioning Expansionary Fiscal Policy" and "Lags and Fiscal Policy".
Equal after-tax pay for equal work and a progressive income tax structure are _____ compatible with each other.
Equal after-tax pay for equal work and a progressive income tax structure are not always compatible. To illustrate, suppose two people are paid $1,000 for doing the same job. If one of them has a higher marginal tax rate, then that person will have less after-tax income. See Section: The Federal Budget
Government expenditures Government purchases
Government expenditures - Federal Government Purchases State Government Purchases Local Government Purchases Government Transfer Payments Government purchases - Federal Government Purchases State Government Purchases Local Government Purchases
Identify whether each scenario in the following table is an example of complete crowding out or incomplete crowding out. The government spends $5 million on food stamps; food stamp recipients then spend $2 million less. The government spends $5 million on food stamps; food stamp recipients then spend $5 million less.
Incomplete, complete. When the government spends $5 million on food stamps, and food stamp recipients then spend $2 million less, this is an example of incomplete crowding out. When the government spends $5 million on food stamps, and food stamp recipients then spend $5 million less, this is an example of complete crowding out. Complete crowding out occurs when a decrease in one or more components of private spending completely offsets the increase in government spending. Incomplete crowding out occurs when the decrease in one or more components of private spending only partially offsets the increase in government spending. If there were zero crowding out, then private sector spending would stay constant when government spending increased. See Section: Crowding Out: Questioning Expansionary Fiscal Policy.
It can take months for policy makers to propose a fiscal policy measure, build support for it, and get it passed. Fiscal policy measures take time to be put into effect once enacted. Policy makers rarely enact counteractive measures immediately. Policy makers are not aware of changes in the economy as soon as they happen. After a policy measure is implemented, it takes time to affect the economy
Legislative, Transmission, Wait-and-see, Data, Effectiveness. The five types of lags include the data lag (policy makers are not aware of changes in the economy as soon as they happen); the wait-and-see lag (policy makers rarely enact counteractive measures immediately); the legislative lag (it can take months for policy makers to propose a fiscal policy measure, build support for it, and get it passed); the transmission lag (fiscal policy measures take time to be put into effect once enacted); and the effectiveness lag (after a policy measure is implemented, it takes time to affect the economy). See Section: Lags and Fiscal Policy.
The ______ tax rate is the rate paid on additional income, while the ______ tax rate is the rate paid on all income.
Marginal, average. The marginal income tax rate is equal to the change in a person's tax payment divided by the change in the person's taxable income. The average tax rate is equal to an individual's tax payment divided by taxable income. See Sections: "Marginal Tax Rates and Aggregate Supply" and "The Laffer Curve: Tax Rates and Tax Revenues".
The bulk of federal government expenditures go to four programs.
National defense, Social Security, Medicare, and Income Security.
For which of the following reasons does crowding out matter to the debate over the effectiveness of fiscal policy in being able to change Real GDP? Check all that apply. If complete crowding out is a regular phenomenon, fiscal policy will likely change the price level but not Real GDP (assuming the SRAS curve is upward sloping). If there is little to no crowding out, then fiscal policy will change Real GDP. If complete crowding out is a regular phenomenon, fiscal policy will not change Real GDP.
The correct answers are If complete crowding out is a regular phenomenon, fiscal policy will not change Real GDP and If there is little to no crowding out, then fiscal policy will change Real GDP. Complete crowding out occurs when a decrease in one or more of the components of private spending completely offsets an increase in government spending. If there is complete crowding out, then an increase in government spending will not cause aggregate demand to rise, so there would be no upward pressure on the price level. Incomplete crowding out occurs when a decrease in one or more of the components of private spending only partially offsets the increase in government spending. If there were zero crowding out, then private sector spending would remain constant when government spending increased. See Section: Crowding Out: Questioning Expansionary Fiscal Policy.
Which of the following describe how crowding out may occur? Check all that apply. Financing the deficit pushes interest rates downward, causing investment to rise. Individuals substitute government goods for private goods. Individuals substitute private goods for government goods. Financing the deficit pushes interest rates upward, causing investment to fall.
The correct answers are Individuals substitute government goods for private goods and Financing the deficit pushes interest rates upward, causing investment to fall. Crowding out refers to a reduction in private spending that results from increased government spending or the need for the government to finance government borrowing. Crowding out can be direct or indirect as described in these two examples that follow: 1.Direct Effect: The government spends more on public libraries, and so people buy fewer books at privately owned bookstores.2.Indirect Effect: The government spends more on social programs and defense without increasing taxes; as a result, the size of the budget deficit increases. In the example of the indirect effect, the government must borrow more funds to finance the larger deficit. The increase in borrowing causes the demand for credit (that is, the demand for loanable funds) to rise, in turn causing the interest rate to rise. As a result, investment drops. Thus, more government spending indirectly leads to less investment spending. See Section: Crowding Out: Questioning Expansionary Fiscal Policy.
How can expansionary fiscal policy end up destabilizing the economy? Check all that apply. It can shift the AD curve to the right at the same time that (unbeknownst to policy makers) the SRAS curve is shifting to the right, so the new SRAS and AD curves intersect at a point greater than Natural Real GDP. It can shift the AD curve too far to the right, so the new SRAS and AD curves intersect at a point greater than Natural Real GDP. It can shift the AD curve to the left at the same time that (unbeknownst to policy makers) the SRAS curve is shifting to the right, so the new SRAS and AD curves intersect at a point greater than Natural Real GDP.
The correct answers are It can shift the AD curve too far to the right, so the new SRAS and AD curves intersect at a point greater than Natural Real GDP and It can shift the AD curve to the right at the same time that (unbeknownst to policy makers) the SRAS curve is shifting to the right, so the new SRAS and AD curves intersect at a point greater than Natural Real GDP. Fiscal policy makers have to be very careful about the underlying economy when they are implementing fiscal policy changes. An increase in AD that occurs when there is an unknown right shift occurring in SRAS, or an increase in AD that is too large, would lead to an equilibrium beyond the Natural Real GDP level. See Section: Lags and Fiscal Policy.
____ deficit will disappear when the economy returns to full employment, while a ______ deficit will not.
The correct answers are cyclical and structural, respectively. Suppose the budget is balanced and then Real GDP drops. The tax base of the economy will then drop as well, and if tax rates are held constant, then tax revenues will also drop. The fall in real GDP will also lead to an increase in transfer payments. This means that when Real GDP falls, government expenditures will rise, but government revenues will fall. Thus, a balanced budget will become a budget deficit. The cyclical deficit refers to that part of the budget deficit that results from a downturn in economic activity. The remainder of the deficit—the part that would exist if the economy were operating at full employment—is called the structural deficit. See Section: Structural and Cyclical Deficits.
Indicate whether each event in the following table is an example of automatic fiscal policy or discretionary fiscal policy. Congress passes a policy consisting of lower taxes and higher government purchases. Unemployment compensation benefits (in total) rise as a result of an increase in the unemployment rate.
The rise in unemployment compensation benefits (in total) as a result of an increase in the unemployment rate is an example of an automatic fiscal policy, whereas Congress passing a policy consisting of lower taxes and higher government purchases is an example of discretionary fiscal policy. When changes in government expenditures and taxes are brought about deliberately through government actions, fiscal policy is said to be discretionary. In contrast, a change in either government expenditure or taxes that occurs automatically in response to economic events is referred to as automatic fiscal policy. See Section: Some Relevant Fiscal Policy Terms.
True or False: Tax revenue will never rise if tax rates are lowered.
The statement is false. Economist Arthur Laffer explained why lower taxes do not always lead to reduced tax revenues, through a diagram that became known as the Laffer curve. According to the Laffer curve, as tax rates rise from zero, tax revenues rise, reach a maximum at some point, and then fall with further increases in tax rates. The Laffer curve illustrates three points: (1) Zero tax revenues will be collected at two (marginal) tax rates: 0% and 100%. Obviously, no tax revenues will be raised if the tax rate is 0%, and if the tax rate is 100%, no one will work and earn income because the entire amount would be taxed away. (2) An increase in tax rates could cause tax revenues to increase, but only up to a maximal point. Thereafter, people would actually work less, and tax revenues would go down. (3) This leads to the third point, namely, that once the tax rate has risen beyond the point where tax revenues are maximized, a decrease in tax rates could cause tax revenues to increase. See Section: The Laffer Curve: Tax Rates and Tax Revenues.
Georgia Dickens is sitting with a friend at a coffee shop talking about the new tax bill. Georgia thinks that cutting tax rates at this time would be wrong. "Lower tax rates," she says, "will lead to a larger budget deficit, and the budget deficit is already plenty big." True or False: Lower tax rates always mean a larger deficit.
The statement is false. Lower tax rates do not always mean a larger deficit. Economist Arthur Laffer explained why lower taxes do not always lead to reduced tax revenues, through a diagram that became known as the Laffer curve. According to the Laffer curve, as tax rates rise from zero, tax revenues rise, reach a maximum at some point, and then fall with further increases in tax rates. The Laffer curve illustrated three points: (1) Zero tax revenues will be collected at two (marginal) tax rates: 0% and 100%. Obviously, no tax revenues will be raised if the tax rate is 0%, and if the tax rate is 100%, no one will work and earn income because the entire amount would be taxed away. (2) An increase in tax rates could cause tax revenues to increase, but only up to a maximal point. Thereafter, people would actually work less and tax revenues would go down. (3) This leads to the third point, which shows that once the tax rate has risen beyond the point where tax revenues are maximized, a decrease in tax rates could cause tax revenues to increase. Thus, in this case, a decrease in tax rates would cause the budget deficit to fall, ceteris paribus. See Section: The Laffer Curve: Tax Rates and Tax Revenues.
True or False: Tax cuts that the public perceives to be temporary affect the SRAS and LRAS curves differently than tax cuts that are perceived to be permanent.
The statement is true. A cut in marginal tax rates increases the returns to investment and work effort and thus encourages people to increase the quantity of investment and labor resources they provide to the economy. A temporary tax cut results in temporary improvements in incentives to invest and work and thus causes a temporary rightward shift of the SRAS curve. A permanent tax cut, by contrast, represents a permanent increase in the investment and labor resources available to the economy and thus a rightward shift of both the SRAS and LRAS curves. See Section: Supply-Side Fiscal Policy.
Tax cuts will likely affect both aggregate demand and aggregate supply. True or False: It matters whether aggregate demand is affected more or whether aggregate supply is affected more.
The statement is true. It matters whether aggregate demand (AD) is affected more or whether aggregate supply (SRAS) is affected more. If both AD and SRAS increase, then real output will increase. However, the effect on the price level in the economy depends on the relative magnitudes of the changes in AD and SRAS. If AD increases by more than SRAS, then the price level will rise. If AD increases by less than SRAS, then the price level will fall. If AD and SRAS increase proportionally, then the price level will remain constant. See Section: Demand-Side Fiscal Policy.
True or False: Under a proportional income tax structure, a person who earns a high income will pay more in taxes than a person who earns a low income.
The statement is true. Under a proportional income tax structure, the same tax rate is charged for all income levels. Therefore, at higher incomes, the tax rate is applied to higher amounts. This means that, under a proportional tax structure, people with high incomes will pay more in taxes than people with low incomes. See Section: Income Tax Structures.