Economics 1022A/B Chapter 29: Fiscal Policy

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Chapter 29 Fiscal Policy Fiscal Policy – the use of the federal budget to achieve macroeconomic objectives such as full employment, sustained long-term economic growth, and price level stability THE FEDERAL B UDGET - Federal budget: annual statement of revenues and outlays of the Government of Canada, together with the laws and regulations that approve and support those revenues and outlays · Purpose = to finance the business of government and to pursue government’s fiscal policy - Provincial budget: annual statement of revenues and outlays of a provincial government, together with the laws and regulations that approve or support those revenues and outlays - Three main items in a federal budget are: · Revenues  $262 billion in 2013 ➢ Personal income taxes – largest revenue source ➢ Corporate income taxes – smallest revenue source ➢ Indirect and other taxes ➢ Investment income · Outlays  $276 billion in 2013 ➢ Transfer payments (payments to individuals, businesses, other levels of government, and rest of the world) ➢ Expenditure on goods and services (government expenditure on final goods/services; G) ➢ Debt interest (interest on government debt) · Budget balance = Revenues – Outlays NX = S – I + T – G ➢ Revenues > outlays, government has a budget surplus T = NX-S+I+G ➢ Outlays > revenues, government has a budget deficit ➢ Revenues = Outlays, balanced budget - Government debt = sum of past deficits – sum of past surpluses · When government budget is in deficit, government debt increases · When government budget is in surplus, government debt decreases SUPPLY -SIDE EFFECTS OF FISCAL POLICY - A decrease in taxes can affect incentives and can increase aggregate supply · Cut in income tax increases supply of labour · Cut in capital taxes increases investment and saving - Effects of the Income Tax · Decreases quantity of labour and lower potential GDP · No effect on demand for labour (LD) because quantity of labour that firms plan to hire depends only on labour productivity and real wage rate · Shifts the supply curve leftward to LS + tax · Before-tax wage rate rises and after-tax wage rate falls · Tax wedge: gap between before-tax and after-tax wage rate - Effects of tax on Capital (Interest) Income · Quantity of capital decreases and potential GDP decreases · No effect on the demand for loanable funds · Shifts the SLF curve leftward to SLF + tax · Saving and investment decreases - The Laffer Curve: the relationship between tax rate and the amount of tax revenue · A higher tax rate does NOT always bring greater tax revenue · A higher tax rate brings in more revenue per dollar earned, but also decreases the number of dollar earned · For tax rates below T*, increase in tax rate increases tax revenue