Question

FISCAL POLICY IN THEORY: March, 2020: we are on the verge of Congress and the President passing legislation that will empower the federal government to spend an unprecedented amount of EXTRA money not seen since World War 2 ---- in order to address the pandemic but also to help cushion the blow financially of perhaps ten or twenty million Americans --- or more --- losing their jobs, and thus suffering a drop in income. The scale of the 2020 recession will not be known for several months, but to say that “we live in interesting times” is the UNDERSTATEMENT OF THE CENTURY. Our government (G) is on the verge of spending perhaps $2 Trillion, perhaps more ----IN ADDITION TO THE roughly $4,400 Billion spent in a “normal” year by our government on Social Security, Medicare, Defense Spending, interest payments on The Debt ($23 Trillion as of November 2019 and RISING VERY MUCH THIS YEAR!!!), “means-tested” payments such as food stamps, housing assistance, mediCAID, (mediCAL in our state) farm programs, and “everything else”---not dozens, but HUNDREDS of other programs that most Americas have never heard of. Last year, our G took in about $3400 Billion in tax revenue and spent about $4400 billion in spending, resulting in a yearly deficit of about $1,000 billion, which was projected to rise to about $1300 billion next year BEFORE THE PANDEMIC. THE FACT THAT THE DEFICIT WILL SKYROCKET THIS YEAR AND THE DEBT WILL RISE MUCH MORE QUICKLY---AND BE HIGHER FOREVER----IS NOT OF GREAT CONCERN IN MARCH OF 2020. I KNOW THAT. But it is OUR JOB to consider the long-run consequences of a rising deficit and debt! We can talk about the ‘bailout package’ in more detail next time, and it is odd to talk about anything else, but here goes: ‘Fiscal Policy’ is the process whereby Congress and the President---in that order, as you can see from the headlines today---direct the Treasury Department to take one of four actions (in theory) : 1. To raise taxes 2. To cut taxes 3. To raise spending 4. To cut spending (in theory---in reality, the federal government NEVER CUTS SPENDING. The last time it did was 1945, when millions of soldiers came home from World War 2). In theory, our government can pursue one or more of these ‘Fiscal Policy’ options in order to achieve one or more of the “5 Goals”—or, if you prefer, the 6 Goals. ( that is, if you wish to include the redistribution of income and wealth as a primary goal of government policy---many of us believe in Goal 6). We MAY wish to call the 5 goals “the 5 goals of Fiscal Policy”---but that idea does not really stand up to scrutiny. LONG BEFORE THE PANDEMIC, our G was borrowing “too much money” for the LONG TERM health of our economy. OBVIOUSLY, our G must, and will, spend a tremendous amount of EXTRA money in 2020 to alleviate human suffering……….. but AT SOME POINT THE PANDEMIC WILL BE OVER, and we will have to face the ever-rising DEBT-DEFICIT CRISIS. More on this later! IN THEORY, our G could try to achieve the 5 goals of : 1. low inflation (i) 2. low unemployment (U) 3. low interest rates (r) and more money in the finite pool, or supply, of loanable funds 4. A high rate of economic growth and 5. A strong, stable economy………… by pursuing one or more of the Fiscal Policy options: 1. A tax hike of $1,000 will take that typical U.S. household that earns, say, $61,000 in gross income and pays $21,000 in taxes, with a net income of $40,000 (in theory), and take $22,000 in taxes, leaving the family with $39,000 to spend. This could be done with a hike in FIT or in FICA, or with a series of new federal sales taxes (or even a federal property tax, in theory). How would a family react? Would they cut back on spending by $1,000? No. It depends on the family, obviously, but if the average family cut back on spending by, say, $700 on average, then the resulting drop in total household spending would likely be enough to cause Total Spending to stop rising, and start falling---a recession. This IN THEORY could help Goal 1, keeping inflation low, and Goal 3, as our G would need to borrow less money from the yearly loan pool as more tax revenue would come in to the Treasury Dept. This policy in theory would be bad for Goal 2, low U, and goals 4 and 5 as the recession, in theory, would hurt the volume of factory construction, home and apartment construction, and net inventory construction…. All this is a fancy way of saying that a lot of workers who had jobs at the start of the year will not have jobs at the end of the year----DEFINITELY true for the year 2020. Note: I do not mean to diminish the value of human life. Many lives will be lost this year, as 110,000 lives in this country were lost in the pandemic of 1957. Option #2, a tax cut, would put another $1,000 into the hands of the average American household. In theory, this policy would help Goals 2, 4, and 5 while undercutting Goals 1 and 3. We have a ‘conflict of goals’ – at least in theory. A rise in G spending, that is, beyond its current levels, in theory, will help Goals 2, 4 and 5 while potentially hurting Goals 1, low inflation, and 3, more money in the loan pool, as THE YEARLY DEFICIT WILL RISE AND OUR G MUST BORROW MORE MONEY FROM THE LOAN POOL. Right now, interest rates are or near an all-time low, so a rise in the national debt (about $23 Trillion in Nov. 2019) does not seem to be a problem.. But that will change. The pandemic will end. Our deficit and debt problems will not.

FISCAL POLICY IN REALITY: IN LATE MARCH, 2020, CONGRESS AND THE PRESIDENT PASSED LEGISLATION THAT WILL ENABLE OUR GOVERNMENT TO SPEND (roughly) AN EXTRA $2 TRILLION ----THAT’S 2,000 BILLION----DOLLARS-----EXTRA ---- IN ADDITION TO THE ROUGHLY $3,500 + BILLION IN SPENDING THAT WAS PLANNED FOR THE YEAR…………THIS IS THE LARGEST BILL OF ITS KIND IN HISTORY….ALL THIS RAISES THE ISSUE: WHAT IS THE PROPER ROLE OF THE GOVERNMENT IN OUR SOCIETY??? IT HAS JUST CHANGED… FOREVER. To say that this is ‘unprecedented’ is an understatement!! The changes in Monetary Policy will be discussed later. My following presentation is a historical look at last year’s numbers---clearly, we will have to add $2,000 Billion (roughly) to these spending numbers. Make no mistake: OUR GOVERNMENT WORKS. You have to form your own opinion about whether this extra spending is a “good” idea or a “bad” idea. There are still some people in our country who believe that our government (G) should NOT have ‘bailed out’ the auto industry in 2008-2009. Incredible, but true. LAST YEAR…. Our G ‘took in’ about $3,400 Billion in tax revenue, mainly through FIT, FICA taxes, federal “sales” or “excise” taxes on various things (gasoline, tobacco, alcohol, tariffs on imports, and MANY other products), and Corporate Income Taxes. Our G spent about $4,400 Billion in various programs that I will mention in a moment. GOVERNMENT SPENDING MUST RISE EVERY YEAR --- EVEN WITHOUT THE NEW $2,000 BILLION IN EXTRA SPENDING! Why? We shall discuss. The $1,000 Billion “gap” between (taxes coming in) and (spending going out) is called THE YEARLY DEFICIT. It was about $1,000 Billion last year, scheduled to rise to about $1,300 Billion this year BEFORE THE EXTRA $2 TRILLION ---- $2,000 BILLION---THIS YEAR IN NEW EXTRA SPENDING! So……………………………..the yearly deficit THIS year might come in at $3,300 Billion???? OR MORE!!!! Maybe $3,400 billion coming in in taxes --- same as 2019, maybe---and roughly $4,800 billion in spending “already planned” plus another $2,000 billion = $6,800 BILLION (!!!!!!!!!!!!!!!!!!!!!!!!!!) in spending…..so…. maybe ($3,400 billion coming in in taxes) and (maybe $6,800 Billion ‘going out’ as spending) for 2020 brings us a yearly deficit of maybe $3,400 Billion FOR THE YEAR 2020!! No one knows exactly--- a lot depends on how much comes in on the tax side! Given that total tax revenue collected for 2020 may be lower than the $3,400 billion in tax revenue collected in 2019 (given the ‘Trump recession’ that we are in)… the deficit for 2020 may exceed $3,400 Billion. (The fiscal year is not the same 12 months as the calendar year). Incredible. This means that our national DEBT will rise by maybe $3,400 billion, starting from a level of about $23 Trillion in November 2019….more on this later….Also, our G may increase spending EVEN MORE… LATER IN THE YEAR……… TO HELP MILLIONS OF U.S. households through the pandemic.. We can look in to the details of the extra $2,000 Billion that our G will spend in 2020 a bit later. Right now, let’s look at the various areas of government spending: how large they were last year, and why they grow every year. After that, we can add the $2,000 Billion in EXTRA spending that our G will engage in for the year 2020. It’s hard to think of anything else, but let us try: the roughly $4,400 Billion that our federal G spent last year breaks down, roughly, in to these areas (you may research all this in greater detail, obviously, if you like): 1. Roughly $1,900 + billion per year spent on: social security (about $1,100+ billion) and mediCARE (roughly $800+ Billion). I call these payments “payments to old people because they are old”—not old and poor… just old….these are not ‘means-tested’ payments. SOCIAL SECURITY: we have over 70 million people, most of them 65 or older, and their qualifying family members, receiving about $1,500 a month ON AVERAGE. Everyone on the program gets over this amount, or under. The benefits are tied to a person’s FICA contributions, which, of course, are higher for higher income workers…. A person who worked a high-wage job all of her life may get $3,000 a month--- I just helped a friend of mine call up Social Security and secure about $3,000 a month in ‘benefits’---(she paid FICA taxes for 50 years, working at a job from age 15 to age 65. She EARNED those “benefits”). A person in the South or Midwest--- or here---who worked a low-wage job all her life may get under $1,500 a month in benefits. MANY MILLIONS OF SENIORS DEPEND ON SS BENEFITS FOR OVER HALF THEIR MONTHLY INCOME. THESE BENEFITS RAISE THEM ABOUT THE POVERTY LINE. OUR GOVERNMENT WOULD NEVER CUT THE CURRENT BENEFITS FOR OLD PEOPLE WHO ARE OLD RIGHT NOW. That is my opinion. OUR G COULD CUT YOUR FUTURE BENEFITS, possibly by ‘raising the age of eligibility’ as it did in 1983, from age 65 (to collect full benefits) to age 67. Could our G raise YOUR age of eligibility for full benefits from age 67 to age 68 or age 69? It is possible. But you guys can vote. Visualize 70 million people getting $1,500 a month in benefits this year. In the next 14 to 24 months, there may be about 72 million people getting about $1,575 a month. Why? More people on the program: think of it as a long, slow train rolling through town. My friend lives on Fuller Ave….. the train rolls RIGHT BY his house….how do you get “on” the train? You turn 65 (in 2020) and call for your benefits. How do you get off? You die. But… when you die, other family members may still receive benefits—it is a very inclusive program. More people are on the train. Every year. There are about 75+ million Americans who were born between 1946 and 1964 (Bush, Obama---1961 in Hawaii,--both Clintons, Trump, who is 72, I believe). All these ‘baby boomers’ are turning 65 from 2011 to 2029. WELL OVER half of them will receive SS benefits. SS benefits are SCHEDULED TO EXPLODE IN SIZE in the next ten years! Also, everyone on the train gets a ‘c.o.l.a.”---a cost of living adjustment…… if inflation runs at about 5% over the next 18 months, in line with the historic average, then every person on the train—in the program—should receive a 5% rise in benefits. In theory, as a nation, we move from about 70 million people earning $1,500 a month to about 72 million people earning $1,575 a month. SOCIAL SECURITY COSTS ARE EXPLODING---even a 5% annual rise will cause this program to DOUBLE in size in 14 years….-MEDICARE: medicare benefits apply to over 57 million older Americans. Medicare is a G-sponsored and G-run health insurance program that provides health insurance for older Americans. It is not perfect and it does not “cover” everything. Once again, I urge you to do your own research on this MASSIVE program if you desire. Medicare will pay for most of your hospital bills, most of your doctor bills and medical equipment and prescription drug costs. Not dental or vision. My sister pays about $150 a month for her medicare insurance, but she also pays for “supplemental” medical insurance as well--- about $300 a month. Why? Medicare does not pay for 100% of the costs of a hospital visit. She told me that a friend of hers had to go to the hospital for a few days and ended up with a bill ---that SHE has to pay---for about $20,000----Medicare paid for most of the bill, which exceeded $80,000---for a few days in the hospital!-----but not all the bill. One could call this a ‘copay’ I suppose. This is what supplemental insurance is supposed to cover, and if you listen to ‘old people’ radio, or other media, old people are FLOODED with ads for this. MEDICARE COSTS ARE RISING AT AN ALARMING RATE---AS THE NUMBER OF SENIORS IN AMERICA DOUBLES OVER TIME!!!!-even a 7% annual rise will cause the program’s costs to double in about 10 years. A 5% rate of rise per year will cause the program to double in cost every 14 years. People talk about ‘bending the curve’ in the pandemic. As a nation, we must ‘bend the curve’ in terms of the explosion of SS AND MEDICARE COSTS….how? we will discuss this later as we grapple with proposals to cut future deficits!! Proposals include raising the monthly premiums on medicare, raising the ’co-payments’, raising the age of eligibility from 65 to 67, and decreasing the number of procedures covered by medicare----‘rationing’ care. All of these ideas have problems…. These two areas, social security and medicare, are rising by at least $100 billion each year, every year. Independent of the EXTRA MONEY our G is spending to help people through the pandemic. DEFENSE SPENDING: $800 billion a year--- every year---and rising. How? Why? Let’s go back to 1945. We just won World War 2. The battlefields WERE IN OTHER COUNTRIES--- not ours…(I think a weather balloon dropped a bomb on a cow in Idaho. Poor cow)…THEIR factories and roads and power plants and water plants----infrastructure---are destroyed, NOT OURS. OURS are INTACT. We bail out Europe with the Marshall Plan (Trump would NEVER go for this). WE are THE military power on planet earth. Europe is in ruins. Also, huge parts of Asia. Our country’s G sets up military bases in Europe, Japan, later South Korea, even Turkey! Turkey is a NATO ally! We have military bases in Turkey! When we study military spending, it is easy to just think of our active-duty soldiers and retired soldiers (veterans). Military spending rises every year, but the Reagan years ---1981 to 1989---saw an acceleration in the rate of rise in spending. It was poised to slow down a bit in the 1990s --- the Clinton era---but a civil war broke out in Eastern Europe, and our response caused a rise in the rate----WE STILL HAVE TROOPS IN THAT PART OF THE WORLD. We have a military presence in Iraq. Afghanistan. Still. Forever? Well, we still have a military presence in Germany….of course, nuclear submarines are small military bases that are deployed throughout the world…once again, please feel free to drill down on all this if you desire…it is very important to note that there are millions of Americans who ARE NOT COUNTED DIRECTLY AS FEDERAL WORKERS….. who work for private-sector firms THAT HAVE CONTRACTS WITH THE GOVERNMENT! In the defense (military) area of G spending, but in all other areas as well….They provide food, computer hardware and software, clothing, security services and dozens of other services and products for our G. Many of these workers are going to be among the best-positioned workers to ‘ride out’ the pandemic, in theory. We must not forget the incredible expense on plant and equipment: military contracts for weapons, planes, tanks, --- a bomb can cost over a million dollars. One bomb. Military spending, including pensions and medical care for retired soldiers, at $800 Billion a year, divided by roughly 330 million Americans, means that, in theory, each person in our country must pay over $2,000 per year EACH---each year, every year….in taxes, for military spending. Over $6,000 a year for a family of three. Now, it does not work that way in reality, but please note that our government SPENDS MORE MONEY ON MILITARY SPENDING THAN THE NEXT FIVE COUNTRIES COMBINED ON PLANET EARTH—and this includes Russia and China! WE ARE THE SUPERPOWER on this planet. Military spending creates A LOT OF JOBS in our economy. Right now, military spending is on a path to rise by at least 30 to 50 Billion each year. ANY PROPOSAL TO CUT MILITARY SPENDING DOWN THE ROAD will be met with FIERCE RESISTANCE by Republicans in the Senate. NO such proposal would be passed by our Congress at this time. Yet, we will look at proposals to cut future deficits. A proposal to “slow down the rate of rise” in military spending should be considered. So far, we have social security, medicare, and defense spending rising by at least $130 billion each year. Next up: interest payments on the debt. The national debt is terribly complex, and there are different definitions of the debt. One measure has it at about $23 Trillion as of Nov. 2019. The Debt was about $1.1 Trillion when Reagan took office in Jan. 1981. Since then, the massive amount of government spending in each year greatly exceeded tax revenue coming in, except for the three years 1998 to 2000. IT IS MUCH MORE COMPLICATED THAN THIS IN REALITY, but let me create a model for you: I’d like you to think in terms of the debt rising by each year’s deficit. The debt is the total amount of money that our G has borrowed. The yearly deficit is the new, additional amount of money that our G borrows in any one year—let’s say from 11/19 to 11/20. Our G pays well over $500 billion per year in ‘interest-only’ payments on the Debt RIGHT NOW. Given the new, extra $2,000 billion that our G will spend this year, for 2020, it is possible that our G will take in about $3,400 billion in taxes and spend about $6,800 billion in spending. Wow. I still cannot believe it. This extra spending is going to minimize the human misery this year. You will have to form your own opinion as to whether it is “good” or “bad” for our country. Our G may be borrowing about $3,400 billion from the yearly loan pool from 11/19 to 11/20. If the numbers I have estimated are close to true, THE DEBT FROM 11/19 to 11/20 MIGHT RISE BY ABOUT $3,400 billion, from about $23 trillion to about $26.4 trillion from 11/19 to 11/20. THIS WILL CAUSE A DEBT-DEFICIT CYCLE: a higher debt will mean higher interest payments—perhaps about 15% higher (in theory)—interest payments will rise by about $75 Billion, from (this is a model) about $500 billion a year to $575billion. As a result, GOVERNMENT SPENDING WILL BE $75 BILLION HIGHER EACH YEAR EVERY YEAR FROM NOW ON. EVEN IF THE $2,000 BILLION STIMULUS IS A ONE-TIME THING, ONLY FOR 2020, OUR G WILL BE “PAYING FOR IT”----every year, forever. Now, G spending will be $75 billion a year HIGHER, EVERY YEAR FROM NOW ON, owing to the rise in the interest payments on the Debt ---EVERY YEAR---FOREVER (in theory) Let’s say after this INCREDIBLE year, 2020, G spending would have returned to about $4,400 billion a year, with tax revenue coming in at about $3,400 billion a year… NO! Now, G spending will be $4,475 billion every year. Now, I know that no one cares about this right now—I even heard someone comment on it today. Yet the fact is, owing to the DEBT-DEFICIT CYCLE, deficits will be higher, every year, forever, and the Debt will be higher, every year, forever. THIS MATTERS IN THE LONG TERM. WE WILL TALK ABOUT ‘CROWDING OUT’ NEXT TIME. So, we have this area of G spending, interest payments on the debt, rising by at least $20 billion a year in a normal year. Next up: ‘MEANS-TESTED PAYMENTS: In the mid 1960s LBJ was able to get passed many spending programs that are aimed at helping children and families “at or near poverty’: MediCAID, food stamps, Head Start, the WIC program, programs for disabled Americans, housing assistance programs. Many of these programs are aimed at children. Children do not vote. People at or near poverty tend not to vote at anywhere near the level the rest of the population votes. One can say you can judge a country by the way it treats its least fortunate members. MediCAID provides medical care for low income families. It has been GREATLY expanded by Obamacare, which Obama signed into law almost exactly ten years ago. Over half the babies born in our state last year were on MediCAID. Does that mean half the babies born last year were born into families with income of less than 138% of the federal poverty line? That’s what it means. The number of people at or near poverty is going to go way up this year. WILL THEY BE THERE ONE YEAR FROM NOW? Two? Three? Do we need a stronger safety net FROM THIS MOMENT FORWARD? Many people believe so---perhaps paid for by taxes on the richest 1% of all Americans. I urge you to do your own research on these VITAL means-tested programs that are literally keeping people alive in our country. Also, our country now spends a LOT more money on services for homeless Americans---an incredibly complex topic. Let’s put this category at $700 billion per year in a normal year (more money spent this year, but let us hope it is short-term) and rising by about 30 billion a year in a normal year on the federal level---state and city and county governments spend a lot as well, with a portion of that money coming from the federal G. As you may know, a good chunk of that $2,000 billion in new, extra spending passed in late March of 2020 will be delivered as money to state and local governments. Next up: Farm Programs. Farmers enjoy a disproportionate amount of political power in our country owing to the Electoral College. Trump is president owing to farmers, even though he lost the popular vote in 2016 by more than 3 million votes. Much of this money is delivered to farmers in the form of “farm price supports” which we deal with in Econ 10B. The $100+ billion spent by our federal G on the behalf of farmers is distributed in many different ways: crop insurance, disaster relief, acreage set-asides (payments not to grow). It is complex, and I urge you to do you own research on the matter. Let’s put farm Programs at $100 billion and rising by 5 to 15 every year. Finally, we have “everything else”: the alphabet soup of HUNDREDS of G programs: foreign aid, OSHA, FDA, NHTSA, EEOC (Labor), CPSC, SEC, IRS, Justice, Homeland Security and hundreds more----these agencies try to ensure that firms are not violating the laws: worker safety laws, laws against ‘too much’ pollution, product safety laws, laws against discrimination and wage theft, laws ensuring accurate reporting of financial data and antitrust violations by firms. Let’s put the amount of G spending in the ‘everything else’ category at well over $400 billion, rising at 20 to 40 billion in a ‘normal’ year. Bottom line: We have G spending at about $4,400 billion last year, rising at a rate of least $170 billion a year in a normal year. G SPENDING MUST RISE EVRY YEAR, even in a ‘normal’ year. And 2020 is not a normal year!

Please answer the following questions:

1. What is fiscal policy in theory? In theory, what could Congress and the President do in order to influence the economy?

2. What is fiscal policy in reality? Please take me through all of the major government spending programs as discussed in the Lectures (in a normal year like fiscal year 2019). Roughly how much money is spent each year by our government in each program? Why is this spending rising over time, in a 'normal' 12 month period?

3. What was the size of the deficit in 2019 (roughly)? What is the size of the deficit in fiscal year 2020 (roughly)? Why the difference? Did something happen this year to change spending, and thus the deficit? What was it?

Answer 1

1.Fiscal policy refers to the use of government spending and tax policies to influence economic conditions, especially macroeconomic conditions, including aggregate demand for goods and services, employment, inflation, and economic growth.

In the United States, fiscal policy is directed by both the executive and legislative branches. In the executive branch, the two most influential offices in this regard belong to the President and the Secretary of the Treasury, although contemporary presidents often rely on a council of economic advisers as well. In the legislative branch, the U.S. Congress passes laws and appropriates spending for any fiscal policy measures. This process involves participation, deliberation, and approval from both the House of Representatives and the Senate.The Constitution really only specifies two legitimate purposes for taxation: to pay the debts of the federal government and to provide for the common defense. Even though an argument could be made that the clause's provisions exclude the use of taxes for fiscal policy purposes, such as a tax-cut bill to expand the economy, basic macroeconomics suggests that any level of taxation has an impact on aggregate demand.

2.Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply.

Government spending covers a range of services provided by the federal, state, and local governments. When the federal government spends more money than it receives in taxes in a given year, it runs a budget deficit. Conversely, when the government receives more money in taxes than it spends in a year, it runs a budget surplus. If government spending and taxes are equal, it is said to have a balanced budget. For example, in 2009, the U.S. government experienced its largest budget deficit ever, as the federal government spent $1.4 trillion more than it collected in taxes. This deficit was about 10% of the size of the U.S. GDP in 2009, making it by far the largest budget deficit relative to GDP since the mammoth borrowing used to finance World War II.

When inflation is too strong, the economy may need a slowdown. In such a situation, a government can use fiscal policy to increase taxes to suck money out of the economy. Fiscal policy could also dictate a decrease in government spending and thereby decrease the money in circulation.

3.GDP growth fell to 6.8% in 2018-19, as per provisional Central Statistics Office (CSO) estimates. RBI, in its June 6 monetary policy review, has estimated GDP growth at 7% for 2019-20, lowering its earlier estimate of 7.2%. The growth in Q4 2018-19 was as low as 5.8%. There are broad-based indicators of a demand slowdown reflected in the index of industrial production (IIP) and purchasing managers’ index (PMI) data.The recently released Controller General of Accounts (CGA) data for 2018-19 indicates that GoI has adhered to the fiscal target of 3.4% of GDP in line with the revised estimates. This was despite the fact that compared to the revised estimates, direct taxes fell short by Rs 74,774 crore and indirect taxes by Rs 93,198 crore.

The union budget has estimated the fiscal deficit for 2019-2020 to be Rs 7.03 lakh crore, or 3.3%of the gross domestic product.