Highlights of the 2008 Budget -The three main items are: -Revenues -Outlays -Budget balance

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1 Government Budgets -There is a federal budget, as well as a provincial budget -Fiscal policy is the use of the federal budget to achieve macroeconomic objectives such as full employment, sustained long-tern economic growth, and price level stability Highlights of the 2008 Budget -The three main items are: -Revenues -Outlays -Budget balance Revenues -Revenues come from four sources: -Personal income taxes -Corporate income taxes -Indirect and other taxes -Investment income -Personal income taxes are the taxes paid by individuals on their incomes -Indirect taxes include the GST and taxes of gasoline, alcohol, and a few other items -Corporate income are taxes paid by companies on their profits -Investment income is the income from government enterprises and investments Outlays -Outlays are classified in three categories: -Transfer payments -Expenditure on goods and services -Debt interest -Transfer payments are payments to individuals, businesses, other levels of government and the rest of the world -Expenditures on goods and services are expenditures on final goods and services -Debt interest is the interest on the government debt Budget Balance -The government s budget balance is equal to its revenues minus its outlays Budget balance = Revenue Outlays

2 Debt and Capital -When individuals and businesses incur debt, they usually do so to buy capital assets that yield a return -In fact, the main point of debt is to enable people to buy assets that will earn a return that exceeds the interest paid on the debt Supply-Side Effects of Fiscal Policy -Fiscal policy has important effects on employment, potential GDP, and aggregate supply Full Employment and Potential GDP -At full employment, the real wage rate adjusts to make the quantity of labour demanded equal the quantity of labour supplied The Effects of the Income Tax -The tax on labour income influences potential GDP and aggregate supply by changing the full employment quantity of labour -The income tax weakens the incentive to work and drives a wedge between the take-home wage or workers and the cost of labour to firms

3 Taxes on Expenditure and the Tax Wedge -Taxes on consumption expenditure add to the wedge -The reason is that a tax on consumption raises the prices paid for a consumption goods and services and is equivalent to a cut in the real wage rate -The incentive to supply labour depends on the goods and services that an hour of labour can buy Taxes and the Incentive to Save -A tax on interest income weakens the incentive to save and drives a wedge between the after-tax interest rate earned by savers and the interest rate paid by firms Effect of Tax Rate on Real Interest Rate -The interest rate that influences investment and saving plans is the real after-tax rate -The real after-tax interest rate subtracts the income tax rate paid on interest income from the real interest rate -If there is no inflation, the nominal interest rate equals the real interest rate Effect of Income Tax on Saving and Investment -A tax on interest income has no effect on the demand for loanable funds -The quantity of investment and borrowing that firms plan to undertake depends only on how productive capital is and what it costs real interest rate

4 -A tax on interest income weakens the incentive to save and lend and decreases the supply of loanable funds -When a tax is imposed, saving decreases and the supply of loanable funds curve shifts leftward Tax Revenues and the Laffer Curve -An interesting consequence of the effect of taxes on employment and saving is that a higher tax rate does not always bring greater tax revenue -A higher tax rate brings in more revenue per dollar earned Stabilizing the Business Cycle -Fiscal policy actions that seek to stabilize the business cycle work by changing aggregate demand and are either: -Discretionary -Automatic -A fiscal policy initiated by an act of parliament is called discretionary fiscal policy -A fiscal action that is triggered by the state of the economy is called automatic fiscal policy

5 Government Expenditure Multiplier -The government expenditure multiplier is the magnification of a change in government expenditure on goods and services on aggregate demand The Autonomous Tax Multiplier -The magnification effect of a change in autonomous taxes on aggregate demand -A decrease in taxes increases disposable income, which increases consumption expenditure The Balanced Budget Multiplier -The magnification effect on aggregate demand of a simultaneous change in government expenditure and taxes that leaves the budget balance unchanged Discretionary Fiscal Stabilization -If real GDP is below potential GDP, discretionary fiscal policy might be used in an attempt to restore full employment -The government might increase its expenditure on goods and services, cut taxes, or do some both -These actions would increase aggregate demand Limitations of Discretionary Fiscal Policy -The use of discretionary fiscal policy is seriously hampered by three time lags: -Recognition lag -Law-making lag -Impact lag Recognition Lag -The time is takes to figure out that fiscal policy actions are needed -Has two aspects: assessing the current state of the economy and forecasting its future state

6 Law-making Lag -The time it takes Parliament to pass the laws needed to change taxes of spending Impact Lag -The time it takes from passing a tax or spending change to its effects on real GDP to be felt Automatic Stabilizers -Automatic fiscal policy is a consequence of tax revenues and outlays that fluctuate with real GDP -These features of fiscal policy are called automatic stabilizers because they work to stabilize real GDP without explicit action by the government Induced Taxes -Taxes that vary with real GDP Transfer Payments -The government creates programs that pay benefits to suitably qualified people and businesses the spending on such programs results in transfer payments that depend on the economic state of individual citizens and businesses -Induced taxes and transfer payments decrease the multiplier effects of changes in autonomous expenditure