Chapter 10. Government Budgets and Fiscal Policy
Introduction to Government Budgets and Fiscal Policy
No Yellowstone Park?
You had trekked all the way to see Yellowstone National Park in the beautiful month of October 2013, only to find it… closed. Closed! Why?
For two weeks in October 2013, the U.S. federal government shut down. Many federal services, like the national parks, closed and 800,000 federal employees were furloughed. Tourists were shocked and so was the rest of the world: Congress and the President could not agree on a budget. Inside the Capitol, Republicans and Democrats argued about spending priorities and whether to increase the national debt limit. Each year’s budget, which is over $3 trillion of spending, must be approved by Congress and signed by the President. Two thirds of the budget are entitlements and other mandatory spending which occur without congressional or presidential action once the programs are established. Tied to the budget debate was the issue of increasing the debt ceiling—how high the U.S. government’s national debt can be. The House of Representatives refused to sign on to the bills to fund the government unless they included provisions to stop or change the Affordable Health Care Act (more colloquially known as Obamacare). As the days progressed, the United States came very close to defaulting on its debt.
Why does the federal budget create such intense debates? What would happen if the United States actually defaulted on its debt? In this chapter, we will examine the federal budget, taxation, and fiscal policy. We will also look at the annual federal budget deficits and the national debt.
Introduction to Government Budgets and Fiscal Policy
In this chapter, you will learn about:
- Government Spending
- Taxation
- Federal Deficits and the National Debt
- Using Fiscal Policy to Fight Recessions, Unemployment, and Inflation
- Automatic Stabilizers
- Practical Problems with Discretionary Fiscal Policy
- The Question of a Balanced Budget
All levels of government—federal, state, and local—have budgets that show how much revenue the government expects to receive in taxes and other income and how the government plans to spend it. Budgets, however, can shift dramatically within a few years, as policy decisions and unexpected events disrupt earlier tax and spending plans.
In this chapter, we revisit fiscal policy, which we first covered in Welcome to Economics! Fiscal policy is one of two policy tools for fine tuning the economy (the other is monetary policy). While policymakers at the Federal Reserve make monetary policy, Congress and the President make fiscal policy.
The discussion of fiscal policy focuses on how federal government taxing and spending affects aggregate demand. All government spending and taxes affect the economy, but fiscal policy focuses strictly on federal government policies. We begin with an overview of U.S. government spending and taxes. We then discuss fiscal policy from a short-run perspective; that is, how government uses tax and spending policies to address recession, unemployment, and inflation; how periods of recession and growth affect government budgets; and the merits of balanced budget proposals.
Watch It
What is fiscal policy? Very simply, it’s a government’s policies on taxes, spending, and borrowing. But how it’s practiced is a little more complicated. Fiscal policy can be used in an effort to mitigate fluctuations in the business cycle – to soften the effects of those booms and busts.
Let’s start by taking a look at expansionary fiscal policy – which leads to something called the “fiscal multiplier.” You see, when government increases spending for a new road during a recession, unemployed workers will be put to work. They’ll earn money, and they’ll start spending that money. The recipients of that spending will in turn spend more, and so on. That initial government spending multiplies.
Now consider an economy that’s operating at full employment (basically everyone that wants a job has one and physical capital is not idle). If the government were to increase spending under these circumstances for a project like a new road, what would happen? It would have to take away some of the resources being put to use in the private sector. The consequences for GDP in this case would be more or less neutral.
In contrast, governments can also practice contractionary fiscal policy. You can probably guess what these policies look like: increased taxes or decreased spending during a boom – or at least that’s the theory. We’ll cover this more in an upcoming video, along with why continual government deficits are common while surpluses are not.
“Introduction to Fiscal Policy” video by MRU is licensed under CC BY-ND 2.0.
