Chapter 28 Macroeconomics- Federal Budgets

Macroeconomics Chapter 28: Federal Budgets Government Outlays • The U.S. government now spends over $3.5 trillion each year—more than $10,000 for every citizen. • Much of the increase was due to spending during and after the Great Recession of 2007– 2009 in an effort to keep the economy from sinking further • Transfer payments: payments made to groups or individuals when no good or service is received in return • Government outlays: category including spending and transfer payments • Mandatory outlays: government spending that is determined by ongoing government programs like Social Security and Medicare (largest portion of federal budget), also includes income assistance, unemployment benefits o Requires changes to laws to change o Sometimes aka entitlement programs because people can be entitled to the benefits under law • Discretionary outlays: government spending that can be altered when the government is setting its annual budget o Includes money for bridges, government workers, foreign aid, and defense • Interest payments: payments made to owners of US treasury bonds o Determined by the level of government debt, not really flexible o Type of mandatory payment • Much of the country’s growth is in mandatory spending since more programs have been added to the government outlay budget Social Security and Medicare • Social security: government-administered retirement funding program o requires workers to contribute a portion of their earnings into the Social Security Trust Fund with the promise that they’ll receive these back (including a modest growth rate) upon retirement o As workers retire and collect benefits, the balance of the Trust Fund declines o ^ To compensate, the social security tax is increased. It is now 12.4% • Medicare: mandated federal program that funds health care for people ages 65+ o requires current workers to pay Medicare taxes with the promise of receiving insurance upon retirement • These two programs count for 40% of all government outlays • Demographic problems o People are living longer meaning more postretirement benefits are needed o Those who paid into the programs for many years are now retired and drawing benefits (in the earlier years of the programs, more people were paying in then taking out) o Baby boomers are now retiring, meaning record number retirees • Proposed solutions: might reduce the benefits paid in the short run and, in doing so, reduce pressure on the federal budget o Increasing retirement age to 67 to 70 o Adjusting the benefits to the consumer price index (CPI were used to adjust benefits payments, the payments would not grow as fast and would still account for inflation) o Means-testing for Medicare and Social Security benefits (decrease the benefits paid to wealthier recipients) Current Fiscal Issues • Why government spending has grown: o Increased spending on social security and medicare o Defense spending after 9/11 o Government responses to the Great Recession, beginning with fiscal policy in 2008 Sources of tax revenue • Two largest sources: individual income tax and the social insurance tax (80%) • Payroll taxes: taxes deducted from workers’ paychecks • Excise taxes: taxes on a particular good or commodity • Customs taxes: taxes on imports, Federal Spending • $3.5 trillion per year • 60% is mandatory • Interest on the national debt is about 7% of federal spending. • Defense spending is 17% of federal spending. • The remaining 17% of the discretionary budget goes to discretionary government spending like highways, bridges, and the salaries of many government employees. Payroll taxes • Social insurance tax: Social Security and Medicare o 40% of the US government outlays are for these o Paid for with taxes on employee’s pay • Income tax o Set according to a scale that increases with income levels o progressive income tax system: people with higher incomes pay a larger percentage of their income in taxes than people with lower incomes do o Tax rates climb with income level o marginal tax rate: the tax rate paid on an individual’s next dollar of income o average tax rate: the total tax paid divided by the amount of taxable income o the average tax rate is below the marginal tax rate in a progressive tax system • Historical income rates o Pre-1931 there was no income tax, most tax revenues were generated by import taxes o During the 30’s, income taxes fell o in 1963, with top marginal rates over 90%, President Kennedy pushed for rate reductions that decreased the top rate to 70% o in the 1980s, President Reagan led the push to lower marginal tax rates even further o In 1993, President Clinton proposed higher rates, and the top rate rose to 39.6% Tax Distributions • In a progressive tax system, the wealthy citizens pay more taxes than poor citizens • The wealthiest 20% of all households paid 69% of all federal taxes • The poorest 40% just paid 4% of federal taxes • Top 1% paid 24% Budget Deficits • budget deficit: occurs when government outlays exceed revenue • budget surplus: occurs when revenue exceeds outlays • When the budget is in deficit, the balance is negative • dollar values for government budget figures are misleading over the long run, because the population and the size of the economy change • ^ for this reason, economists look at deficits as a portion of GDP • Since the onset of the Great Recession at the end of 2007, outlays, revenues, and deficits have all reached historic magnitudes • Deficits increase during recessions because: o Government outlays increase in recessions o Taxes decrease in recessions • when tax revenues fall short of outlays, the government sells Treasury bonds to cover the difference Deficit vs Debt • deficit: a shortfall in revenue for a particular year’s budget • debt: the total of all accumulated and unpaid budget deficits • publicly held portion: government debt that is not also owned by the government itself • austerity: strict budget regulations aimed at debt reduction Foreign Ownership of US Debt • about 67% of U.S. national debt was held domestically as of 2013 • foreign lending increases the supply of loanable funds in the United States, which helps keep interest rates low • Lower interest rates mean that US firms/governments can borrow at lower cost • increase in foreign ownership is a natural by-product of emerging foreign economies—as nations get wealthier, they buy more U.S. Treasury bonds. Bonus Notes: • 2014 fed spending: Bonus: • In order to maintain a constant level of worker productivity, the total amount of capital available to them must increase at a rate at least equal to population growth. • A decrease in the price level will decrease the nominal interest rate and cause a downward movement along the aggregate demand curve. • If short-run equilibrium output is above full-employment output, then in the long run input prices will increase and output will fall • Economic growth in the rest of the world slows down. In the short run, one can expect output in the United States to decrease and the price level to decrease. • According to classical economics, a decrease in aggregate demand causes the price level to decrease in the long run. In contrast, an increase in aggregate demand causes the price level to increase in the long run. These changes occur because of price flexibility • Interest payments are considered mandatory spending because not making such payments could endanger the government’s credit rating, which could make it harder to borrow going forward. • The US had a balanced budget as recently as 2001 • The U.S. national debt is purchased by entities in the form of treasury securities • Random example: o Total consumption is the sum of autonomous consumption ($20 billion) and the result of multiplying GDP and Marginal Propensity to Consume (= $75 billion) =$95 billion. That is, total consumption = autonomous consumption + (GDP× Marginal Propensity to Consume). Given GDP is $100 billion and there is no government spending or net exports, then autonomous planned investment is $5 billion. • It took 3 more years for the economy to recover from the Great Depression compared to the Great Recession. • • During the worst part of the Great Depression, cyclical unemployment was equal to 21%. During the worst part of the Great Recession, cyclical unemployment was equal to 5%.