Other Issues in Fiscal Policy

There are three other aspects of fiscal policy: automatic stabilizing influence of fiscal policy, the multiplier effect, and the propensity to spend or save.

First, fiscal policy exerts an automatic stabilizing effect on the economy, even when the government makes no explicit changes in its tax or spending plans.

When the economy contracts, tax receipts automatically decrease (because incomes decrease). The effect is magnified by progressive taxation, (when the system is applying higher tax rates to higher incomes). Workers who are laid off automatically fall into a lower tax bracket. Their lower taxes will partially offset the effect of their lost income. Similarly, when incomes rise, particularly during inflation, bracket creep* pushes people into higher tax brackets. The higher taxes they pay take money out of their pockets – money they can no longer use to bid prices up even higher.

Government spending also acts as an automatic stabilizer, especially during downturns. The government tends to maintain its general level of spending during recession, which insures a solid baseline level of demand from government in C+I+G (Consumers, Investment, Government) formula. Also, programs of unemployment insurance and public assistance help to ease the burden of tough times on households.

Second, the multiplier will boost the effect of an increase or reduction in taxes or spending. For instance, an extra dollar government spending will flow through the economy and, by being repeatedly respent, will magnify the stimulus provided by that dollar. Likewise, a dollar or reduced spending will take a dollar out of the economy, and the multiplier applies to that as well.

Finally, like the multiplier, the propensities to spend and to save are at work. If the government reduces taxes to stimulate consumption, but households save money rather than to spend it, consumption will not rise, nor will investment. If people save the money, they are “sitting on their wallets” and consumption remains low. Is consumption is low, businesses won’t invest. This has been a problem in the application of fiscal stimulus in Japan, where people tend to save increases in income.

Note:

1. bracket creep – переход в группу населения с доходами, подлежащими обложению налогами по более высоким ставкам

Ex. 1. Based on your understanding of the text, are the following TRUE or FALSE?

1. Fiscal policy exerts an automatic stabilizing effect on the economy, even when the government makes no explicit changes in its tax or spending plans.

2. When the economy contracts, tax receipts automatically increase.

3. Workers who are laid off automatically fall into a higher tax bracket.

4. The multiplier will boost the effect of an increase or reduction in taxes or spending.

5. If the government reduces taxes to stimulate consumption, but households save money rather than to spend it, consumption will not rise, nor will investment.

6. If people save the money, they are “sitting on their wallets” and consumption increases.

Ex. 2. Based on your understanding of the text, are the following TRUE or FALSE?

1. Automatic stabilizers are federal expenditures and tax revenues. They automatically change levels in order to stabilize an economic expansion or contraction.

2. When the economy expands government spending for unemployment compensation, welfare, and other transfer payments increases.

3. During an expansion, jobs are created, unemployment falls, and workers earn less income and therefore pay less taxes.

4. Changes in federal spending and taxes moderate changes in aggregate demand.

Ex. 3. Find information in the text to answer the following questions.

1. What are automatic stabilizers?

2. How does the multiplier work?

3. How can you account for the term propensity to consume or to save?

Text 3

Here are the opinions of two well-known North American economists about the role of the government or the state. Read the texts and describe Galbraith’s and the Friedman’s views on the role of the government. Which opinion do you find more reasonable?

A.