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.

The Role of Government

The first is an extract from a talk by J.K. Galbraith.

The good society accepts the basic market system and its managers, but there are some things the market system does not do either well or badly. In the good society these are the responsibility of the state.

Some areas of state action are evident. In no country does the market system provide good low-cost housing. This is a matter of prime importance and must everywhere be a public responsibility. Few things are more visibly at odds¹ with the good society than badly housed or homeless people.

Health care is also a public responsibility in all civilized lands. No one can be assigned to illness or death because of poverty. Here Britain can proudly point to its leadership.

The state has many other essential functions. It must also be borne in mind that many of these – parks and recreational facilities, police, libraries, the arts, others – are more needed by the underclass than by the affluent. Those who attack the services of the state are usually those who can afford to provide similar services for themselves.

In the good society, there must also be attention to a range of activities that are beyond the time horizons of the market economy. This is true in the sciences, not excluding medical research. The market system invests for relatively short-run return. To support science is pre-eminently the responsibility of the state.

Some of the truly important industrial achievements of recent generations – the great improvements in agricultural productivity, modern air transport, advanced electronics – have depended heavily on such public investment. Necessary also – a matter we are beginning reluctantly to recognize – is investment and regulation in the longer-run interest of the environment. The good society protects and improves life in its planetary dimension.

B. Here is an extract from Milton and Rose Friedman’s book “Free to Choose”.

Though the United States has not adopted central economic planning, we have gone very far in the past 50 years in expanding the role of government in the economy. That intervention has been costly in economic terms. The limitations imposed on our economic freedom threaten to bring two centuries of economic progress to an end. Intervention has also been costly in political terms. It has greatly limited our human freedom.

An essential part of economic freedom is freedom to choose how to use our income: how much to spend on ourselves and on what items; how much to save and in what form; how much to give away and to whom. Currently, more than 40% of our income is disposed of on our behalf by government at federal, state and local levels combined.

As consumers, we are not even free to choose how to spend that part of our income that is left after taxes. We are not free to buy cyclamates or laetrile, and soon, perhaps, saccharin. Our physician is not free to prescribe many drugs for us that he may regard as the most effective for our ailments, even though the drugs may be widely available abroad. We are not free to buy an automobile without seat belts.

Another essential part of economic freedom is freedom to use the resources we possess in accordance with our own values – freedom to enter any occupation, engage in any business enterprise, buy from or sell to anyone else, so long as we do so on a strictly voluntary basis and do not resort to force in order to coerce others.

Today you are not free to offer your services as a lawyer, a physician, a dentist, a plumber, a barber, a mortician, or engage in a host of other occupations, without first getting a permit or license from a government official. You are not free to work overtime at terms mutually agreeable to you and your employer, unless thee terms conform to rules and regulations laid down by a government official.

You are not free to set up a bank, go into the taxicab business, or the business of selling electricity or a telephone service, or running a railroad, busline, or airline, without first receiving permission from a government official.

Freedom cannot be absolute. We do live in an interdependent society. Some restrictions on our freedom are necessary to avoid other, still worse, restrictions. However, we have gone far beyond that point. The urgent need today is to eliminate restrictions, not add to them.

WRITING

Read the text below and write an abstract using the following clichés: The text is headlined; the main idea of the text is; the aim of the text is to provide the reader with some data on …; the text is divided into … parts ; the first part deals with …; the second part tells of…; the third part touches upon …; in conclusion the text reads…; I found the text interesting/ important/ boring/ of no value ;it is easy/hard to understand.

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