Fiscal policy, government expenditures, and national debt in macroeconomic analysis

Fiscal Policy

The three major categories of revenue for the federal government are individual income taxes, corporate income taxes and social insurance taxes. The most important of these are the individual income taxes, which represent 55.1% of the total budget revenues, or $1.396 trillion. The second-most important revenue category is the social insurance taxes, which account for $978 billion, or 34.6% of the total budget revenues. The third-most important category is the corporate income taxes, which amount to $290 billion, or 10.3% of total budget revenues. The "other" category of revenues accounts for the remaining 5.7% of total budget revenues.

The three major categories of expenditures are mandatory spending, discretionary spending and interest. The largest of these is mandatory spending, which accounts for $1.914 trillion, or 57.5% of total outlays. The second-most important category of spending is the discretionary spending, which accounts for $1.189 trillion, or 35.2% of total budget outlays. Interest accounts for $220 billion, or 6.6% of total budget outlays.

3. As Chief Economic Adviser to the President of the United States, I would have the following to say about the deficit reduction proposals listed in Fried (2010). The total deficit in 2011 is project to be $498 billion, which is 14.9% of the total budget and 3.3% of GDP. The first proposal outlined in the article is the first I agree with - to overhaul the individual taxation system. The different proposals listed therein are short on specifics -- it matters as to what rate changes fall to what taxpayers. Key elements of tax reform -- getting rid of the Bush tax cuts and taxing capital gains as income -- will certainly increase individual tax revenue. A new sales tax would increase individual tax revenue, or create a new tax category. In any event, there is little political will for a nationwide sales tax or even for changing the way that capital gains are taxed. If these options were feasible, they would be recommended as a strong starting point for increasing individual taxation revenue.

The Domenici-Rivlin proposal to reduce corporate tax rates would reduce corporate tax revenue. There is no evidence that this would do anything to raise tax revenue anywhere else, unless it was coupled with a move to tax capital gains as income. In that situation, firms might have more profits but their shareholders would pay far more tax on those profits. Firms would likely pay more dividends, so it might be important to keep the dividend tax rate equal to the capital gains tax rate. I would not support this if there is no effort to increase tax rates on capital gains and dividends as without those things a lower corporate tax rate would only increase the deficit.

With respect to social security plans, the Simpson-Bowles plan is worthless. The policy of raising the normal retirement age, but only after the bulk of the baby boomers -- already the wealthiest generation in history - get their money, is ridiculous. The upcoming baby boomer retirements and corresponding entitlements that are going to cause the greatest stress on the national budget; dealing with the deficit requires curtailing entitlements to the wealthiest generation in American history. Kicking the can down the road on social security is a cop-out that does nothing to address the deficit situation any time soon. Raising the upper limit on the social security tax would generate more revenue right away, which is going to be needed if there are not going to be any pending benefit cuts.

The Medicare plan is said to generate $85 billion over ten years, which at an average of $8.5 billion per year does not make a serious contribution to deficit reduction (1.7% of the deficit in 2011). There are other savings as well, but they are minor and neither plan addresses the only serious solution to Medicare funding -- means testing. Paying medical benefits to millionaires is poor value for taxpayer money yet no politician has the courage to adopt this sensible approach to curtailing the growth in Medicare costs. That there can be so much opposition to providing health care benefits to poor people of working age and so little opposition to providing them to rich old people is patently absurd. Along with some of the other proposals, means-testing can result in serious reduction in Medicare costs.

Simpson-Bowles wants to cut $200 billion in defense and domestic programs by 2015, when the deficit is projected to be $234 billion -- clearly if these cuts are possible the deficit could be mostly eliminated. These cuts would need to be outlined in more detail to determine how feasible they are. Increasing fees for the Smithsonian and national parks is pointless and petty -- a total of $300 million, or 0.1% of the deficit. The impact of these cuts on American culture life is not worth the money saved. Overall, these plans are too vague in the key details to fully assess, but this vagueness combined with cowardly stances on Medicare and Social Security leave one to wonder where any of these people will find the stones to actually make a serious proposal on deficit reduction. Finding things to like about either of these plans is actually kind of difficult, since they do not directly address the key problems, and seem to only propose solutions that dance around the issue and pay lip service to "cuts" without detailing them in an appropriate manner for a budget proposal.

4. The most important way to lower the unemployment rate is to focus on increasing government spending to offset the decline in private investment and consumer spending. Consumers have too much debt still, so proposals to get them spending again will not constitute a long-term solution. Government spending instead should be the short-term solution until the economy is working well. Some of this can be focused on work programs, grants to employers to create jobs, and retraining programs for workers who are approaching long-term, non-cyclical unemployment. When the economy is growing again and unemployment is at a healthier level, this government support of the economy must cease. Ideally, we won't have unfunded wars and tax cuts to squander boom-time surpluses next time, so that we are better prepared for the next recession.

5. A. The equilibrium point of AS and AD is where demand and supply are equal.

B. If the federal government cuts spending, this will reduce AD. Not only will spending be reduced, but this will affect consumers, some of whom will have seen their government jobs disappear or wages cut. The result is that both G. And C. will decrease, lowering AD.