Chapter 31
Intro:
To some degree, government tax revenues change automatically over the course of the
business cycle and in ways that stabilize the economy. This automatic response, or built-
in stability, constitutes nondiscretionary (or “passive” or “automatic”)
Virtually any tax will yield more tax revenue as GDP rises. In particular, personal income
taxes have progressive rates and thus generate more-than-proportionate in- creases in
tax revenues as GDP expands.
Transfer payments (or “negative taxes”) behave in the opposite way from tax revenues.
Unemployment compensation payments and welfare payments decrease during
economic expansion and increase during economic contraction.
Built-in stabilizer
A built-in stabilizer is anything that increases the government’s budget deficit (or
reduces its budget surplus) during a recession
AND increases its budget surplus (or reduces its budget deficit) during an expansion
without requiring explicit action by policymakers.
Government expenditures G are fixed and assumed to be independent of the level of
GDP.
Congress decides on a particular level of spending, but it does not determine the
magnitude of tax revenues.
Line T represents that direct relationship between tax revenues and GDP.
Economic importance:
Tax revenues automatically increase as GDP rises during prosperity, and since taxes
reduce household and business spending, they restrain the economic expansion.
As the economy moves toward a higher GDP, tax revenues automatically rise and move
the budget from deficit toward surplus
With a falling GDP, tax receipts decline and move the government’s budget from surplus
toward deficit.
Tac progressiveness:
If tax revenues change sharply as GDP changes, the slope of line T in the figure will be
steep and the vertical distances between T and G (the deficits or surpluses) will be large.
The steepness of T in Figure 31.3 depends on the tax system itself. In a progressive tax
system, the average tax rate (5 tax revenue/GDP) rises with GDP.
In a proportional tax system, the average tax rate remains constant as GDP rises. In a
regressive tax system, the average tax rate falls as GDP rises.
The progressive tax system has the steepest tax line T of the three. However, tax
revenues will rise with GDP under both the progressive and the proportional tax
systems, and they may rise, fall, or stay the same under a regressive tax system.
The main point is this: The more progressive the tax system, the greater the economy’s
built-in stability.
, Fiscal Policy during and after the Great
Recession
Major economic trouble began in the summer of 2007, where crisis in the market for
mortgage loans flared up.
Later in 2007 that crisis spread rapidly to other financial markets, threatened the survival
of several major U.S. financial institutions, and severely disrupted the entire financial
system.
As credit markets began to freeze, general pessimism spread beyond the financial
markets to the overall economy.
Businesses and households saved on their borrowing and spending.
December 2007 the economy entered a recession.
became known as the Great Recession—one of the steepest and longest economic
downturns since the 1930s.
As a percentage of GDP, the actual federal budget deficit increased
The government hoped that those receiving checks would spend the money and thus
boost consumption and aggregate demand. But households instead saved substantial
parts of the money from the checks or used some of the money to pay down credit card
loans.
With the economy continuing its precipitous slide, the Obama administration and
Congress enacted the American Recovery and Reinvestment Act of 2009.
The recession officially ended during the summer of 2009, but the economy did not
rebound vigorously. Unemployment remained elevated and tax collections were low due
to a stagnant economy. As a result, policymakers decided to continue with large amounts
of fiscal stimulus.
Intro:
To some degree, government tax revenues change automatically over the course of the
business cycle and in ways that stabilize the economy. This automatic response, or built-
in stability, constitutes nondiscretionary (or “passive” or “automatic”)
Virtually any tax will yield more tax revenue as GDP rises. In particular, personal income
taxes have progressive rates and thus generate more-than-proportionate in- creases in
tax revenues as GDP expands.
Transfer payments (or “negative taxes”) behave in the opposite way from tax revenues.
Unemployment compensation payments and welfare payments decrease during
economic expansion and increase during economic contraction.
Built-in stabilizer
A built-in stabilizer is anything that increases the government’s budget deficit (or
reduces its budget surplus) during a recession
AND increases its budget surplus (or reduces its budget deficit) during an expansion
without requiring explicit action by policymakers.
Government expenditures G are fixed and assumed to be independent of the level of
GDP.
Congress decides on a particular level of spending, but it does not determine the
magnitude of tax revenues.
Line T represents that direct relationship between tax revenues and GDP.
Economic importance:
Tax revenues automatically increase as GDP rises during prosperity, and since taxes
reduce household and business spending, they restrain the economic expansion.
As the economy moves toward a higher GDP, tax revenues automatically rise and move
the budget from deficit toward surplus
With a falling GDP, tax receipts decline and move the government’s budget from surplus
toward deficit.
Tac progressiveness:
If tax revenues change sharply as GDP changes, the slope of line T in the figure will be
steep and the vertical distances between T and G (the deficits or surpluses) will be large.
The steepness of T in Figure 31.3 depends on the tax system itself. In a progressive tax
system, the average tax rate (5 tax revenue/GDP) rises with GDP.
In a proportional tax system, the average tax rate remains constant as GDP rises. In a
regressive tax system, the average tax rate falls as GDP rises.
The progressive tax system has the steepest tax line T of the three. However, tax
revenues will rise with GDP under both the progressive and the proportional tax
systems, and they may rise, fall, or stay the same under a regressive tax system.
The main point is this: The more progressive the tax system, the greater the economy’s
built-in stability.
, Fiscal Policy during and after the Great
Recession
Major economic trouble began in the summer of 2007, where crisis in the market for
mortgage loans flared up.
Later in 2007 that crisis spread rapidly to other financial markets, threatened the survival
of several major U.S. financial institutions, and severely disrupted the entire financial
system.
As credit markets began to freeze, general pessimism spread beyond the financial
markets to the overall economy.
Businesses and households saved on their borrowing and spending.
December 2007 the economy entered a recession.
became known as the Great Recession—one of the steepest and longest economic
downturns since the 1930s.
As a percentage of GDP, the actual federal budget deficit increased
The government hoped that those receiving checks would spend the money and thus
boost consumption and aggregate demand. But households instead saved substantial
parts of the money from the checks or used some of the money to pay down credit card
loans.
With the economy continuing its precipitous slide, the Obama administration and
Congress enacted the American Recovery and Reinvestment Act of 2009.
The recession officially ended during the summer of 2009, but the economy did not
rebound vigorously. Unemployment remained elevated and tax collections were low due
to a stagnant economy. As a result, policymakers decided to continue with large amounts
of fiscal stimulus.
