SOLUTIONS TO SELF-CHECK QUESTIONS

10.1 Government Spending

1. The government borrows funds by selling Treasury bonds, notes, and bills.
2. The funds can be used to pay down the national debt or else be refunded to the taxpayers.
3. Yes, a nation can run budget deficits and see its debt/GDP ratio fall. In fact, this is not uncommon. If the deficit is small in a given year, than the addition to debt in the numerator of the debt/GDP ratio will be relatively small, while the growth in GDP is larger, and so the debt/GDP ratio declines. This was the experience of the U.S. economy for the period from the end of World War II to about 1980. It is also theoretically possible, although not likely, for a nation to have a budget surplus and see its debt/GDP ratio rise. Imagine the case of a nation with a small surplus, but in a recession year when the economy shrinks. It is possible that the decline in the nation’s debt, in the numerator of the debt/GDP ratio, would be proportionally less than the fall in the size of GDP, so the debt/GDP ratio would rise.

10.2 Taxation

1. Progressive. People who give larger gifts subject to the higher tax rate would typically have larger incomes as well.
2. Corporate income tax on his profits, individual income tax on his salary, and payroll tax taken out of the wages he pays himself.
3. individual income taxes
4. The tax is regressive because wealthy income earners are not taxed at all on income above $113,000. As a percent of total income, the social security tax hits lower income earners harder than wealthier individuals.

10.3 Federal Deficits and the National Debt

1. 1. As debt increases, interest payments also rise, so that the deficit grows even if we keep other government spending constant.
   2. True/False:

1. As a share of GDP, this is false. In nominal dollars, it is true.
2. False.
3. False.
4. False. Education spending is much higher at the state level.
5. False. As a share of GDP, it is up about 50.
6. As a share of GDP, this is false, and in real dollars, it is also false.
7. False.
8. False; it’s about 1%.
9. True. Ever since the brief period of federal budget surplus from 1998-2001, deficits have been quite large. This can be attributed to the Great Recession and the COVID-19 Recession.
10. True, due to the COVID-19 pandemic.

10.4 Using Fiscal Policy to Fight Recession, Unemployment, and Inflation

1. To keep prices from rising too much or too rapidly.
2. To increase employment.

10.5 Automatic Stabilizers

1. It falls below because less tax revenue than expected is collected.
2. Automatic stabilizers take effect very quickly, whereas discretionary policy can take a long time to implement.
3. In a recession, because of the decline in economic output, less income is earned, and so less in taxes is automatically collected. Many welfare and unemployment programs are designed so that those who fall into certain categories, like “unemployed” or “low income,” are eligible for benefits. During a recession, more people fall into these categories and become eligible for benefits automatically. The combination of reduced taxes and higher spending is just what is needed for an economy in recession producing below potential GDP. With an economic boom, average income levels rise in the economy, so more in taxes is automatically collected. Fewer people meet the criteria for receiving government assistance to the unemployed or the needy, so government spending on unemployment assistance and welfare falls automatically. This combination of higher taxes and lower spending is just what is needed if an economy is producing above its potential GDP.

10.6 Practical Problems with Discretionary Fiscal Policy

1. Prices would be pushed up as a result of too much spending.
2. Employment would suffer as a result of too little spending.
3. Monetary policy probably has shorter time lags than fiscal policy. Imagine that the data becomes fairly clear that an economy is in or near a recession. Expansionary monetary policy can be carried out through open market operations, which can be done fairly quickly, since the Federal Reserve’s Open Market Committee meets six times a year. Also, monetary policy takes effect through interest rates, which can change fairly quickly. However, fiscal policy is carried out through acts of Congress that need to be signed into law by the president. Negotiating such laws often takes months, and even after the laws are negotiated, it takes more months for spending programs or tax cuts to have an effect on the macroeconomy.

10.7 The Question of a Balanced Budget

1. The government would have to make up the revenue either by raising taxes in a different area or cutting spending.
2. Programs where the amount of spending is not fixed, but rather determined by macroeconomic conditions, such as food stamps, would lose a great deal of flexibility if spending increases had to be met by corresponding tax increases or spending cuts.