Stanford University Fiscal Policy Paper

I'm working on a accounting discussion question and need an explanation and answer to help me learn.

Fiscal policy refers to the changes in government’s choices regarding the overall level of government spending and taxes to influence the behavior of the economy. Fiscal policy can expand or contract aggregate demand. The government sometimes uses the fiscal policy instruments in an attempt to stabilize the economy. Under a recession, an expansionary fiscal policy is adopted, which involves lowering taxes and/or increasing government spending. In an overheated expansion with an inflationary pressure, a contractionary fiscal policy is utilized, which requires higher taxes and/or reduced government spending. Economists and policymakers disagree about how active the government should be in these fiscal policy efforts.

Based on the above summary and the detailed descriptions of the fiscal policy issues in the textbook (Chapter 33) discuss the following questions:

• What are the expansionary and contractionary fiscal policies? What are their policy instruments? How are they used to deal with the inflationary gap and recessionary gap? Which do you think is more appropriate today?
• Should the government balance its budget? If you think it should, what steps do you suggest that it take to balance its budget?
• What is the relationship between budget deficits and national (public) debt? Why the U.S. national debt has been increasing for decades?
• Should the tax laws be reformed to encourage saving? Do you think consumption tax is better than income tax?

Do the discussion with references and citation then response each posted down below #1-3

Posted 1

Fiscal policy can be described as the influence/effect on the economy as a result of government spending or taxation, in other words this can be said to be a form of government intervention. In order to restore a nation’s economic equilibrium, government can decide to use fiscal policy to reduce an inflationary gap by decreasing the number of funds circulating within the economy or through government spending, tax increases, bond and securities issues, and transfer payment reductions (McConnell, 2021). Expansionary fiscal policy happens often in the case of recession, the government makes the decision to cut tax rates or increase their disposable income, while contractionary fiscal policy happens when the government makes the decision to raise tax rates/cut their spending or a combination of both to decrease aggregate demand and control inflation (Weil, n.d.).

Based on the current state the nation is in, I believe the government needs to use the expansionary fiscal policy to close recessionary gaps and stimulate the economy. Government needs to consider deficit reduction policies, which may include raising taxes and/or reducing spending (CRS Reports., 2021). As such, if the government decides to balance the budget now, it would cause more harm than good to the economy. A balanced budget runs the risk of pushing the nation into even more crisis, it would undercut programs that have built up reserves and would make the recession last longer and happen more frequently resulting in unemployment which would affect the long-term growth of the economy.

Budget deficit is the difference between what the federal government spends and what it brings in from income generating activities while national debt is the accumulation of government’s yearly budget deficits. The U.S has been in debt for many decades now and the nation’s deficit seems to only be increasing because of the crisis on GDP and tax revenues as well as the cost of the fiscal response to the crisis. Simply put, the government overspends because the of the availability of debt ceiling, and the fact that it has continuously been raised. In the events of government reaching the debt ceiling limit, they decide to finance existing obligations (Rappeport, 2021).

Tax laws do not need to be reformed in order to encourage savings because it would mostly benefit people who are already wealthy and have less of an effect on low income families, it would reduce the tax burden on the wealthy but would raise that of the poor. Income tax is tax on what a person earns from working while consumption tax is the tax on what a person spends their money on (McConnell, 2021). I think consumption tax is better than income tax because it encourages saving and investment and makes the economy more efficient, while the latter penalizes savers and rewards spenders.

Posted 2

Fiscal policy refers to decisions made by government entities (i.e. the Treasury) in order to influence the economy. These can include expansionary actions, meant to stimulate the economy, and contractionary actions, meant to slow down the growth of the economy. The most important reason the government does this is to balance inflation and unemployment so neither runs away and creates a situation that is out of control. Due to this, and other market forces, there is a typical cycle of inflation and recession of the economy of any particular nation. In the United States, the responsibility of control over this cycles is divided by fiscal policy and monetary policy (handled by the Federal Reserve).

Government spending is an active piece of fiscal policy, and spending more than it actually brings in in revenue is a regular occurrence. This is often compared to a household that puts a lot of their expenses on credit and just keeps putting off paying off the debt. This is not a completely fair comparison, since the US Government can create bonds to finance their debt and a household cannot. Government debt is typically thought of as a safe investment, and will therefore always have high demand at times that investors are worried.

All this combined is why government overspending their budget is not nearly the concern the media would have the average investor believe. More like a mortgage, the big nominal number means little; it is a questions of whether you can afford the interest payments. Based on the 2020 US Government budget, interest payments made up only 5% of the government’s budget and was only the 7^th largest single budget item (Federal Spending by Category and Agency, 2021). To put it simply, if we can continue to afford Social Security payments and the military budget (17% and 11% respectively), then the net interest payments are very affordable by comparison.

Posted 3

Expansionary Fiscal Policy: The expansionary fiscal policy is typically a response to a recession; it uses tax cuts, increases in government spending, or a combination of both, to help the economy out of a recession (McConnell, Brue, & Flynn, 2018). This creates a government budget deficit since the government is spending more than the tax revenues.

Contractionary Fiscal Policy: The contractionary fiscal policy is a restrictive policy to counteract demand-pull inflation. It uses decreases in government spending or increased taxes to reduce inflation (McConnell, Brue, & Flynn, 2018). It is the opposite of the policies/instruments used in the expansionary fiscal policy. Contractionary fiscal policies are important to mitigate inflationary GDP gaps: if output prices rise long-term then input prices must rise too, which causes further inflation. This type of fiscal policy creates a government budget surplus since government spending is lower than tax revenues. Contractionary fiscal policy must also account for the ratchet effect: the idea that price levels act like ratchets where increases in aggregate demand drive price up but declines in aggregate demand do not drive price down (McConnell, Brue, & Flynn, 2018). Thus, the government must aim to stop the rising price levels instead of lowering them.

The U.S. is currently in a recessionary period, so an expansionary policy to create a government budget deficit would be more appropriate today.

I don’t think that the government should balance its budget. In January 2019, the house judiciary committee proposed a balanced budget amendment to the constitution that would require the government to balance the budget each fiscal year (116^th Congress, 2019). The idea behind it is to put debt levels on a sustainable trajectory, but I think all the actions required to balance the budget, including spending cuts and tax increases, would have more detrimental effects on the economy; it could potentially lower tax revenue and increase the deficit, causing the government to spend more to offset the consequences.

National public debt is “the total accumulation of the deficits (minus the surpluses) the federal government has incurred through time” (McConnell, Brue, & Flynn, 2018). Total public debt represents how much money the Federal government owes to U.S. securities holders. The budget deficits refer to specific points in time, say a year, wile the national public debt looks at the accumulation of budget deficits over time.

The U.S. national debt has been increasing for decades because it is an accumulation of federal budget deficits. It consists of Treasure notes, bills, and bonds, and U.S. savings bonds. However, this does not mean that the government is going to go bankrupt because the debt can be refinanced and the government can increase taxes to make payments (McConnell, Brue, & Flynn, 2018).

Yes, tax laws should be reformed to encourage savings: tax reduction increases savings and decreases consumption (McConnell, Brue, & Flynn, 2018). Consumption taxes are taxes such as sales tax, specific excise taxes, and value-add taxes, that the United States relies heavily on (McConnell, Brue, & Flynn, 2018). In terms of encouraging saving I do think that consumption tax is better than income tax because individuals have control over their spending and how much consumption tax they incur. However, individuals have little say in their personal income tax and its effect on their financial standing.