MacroeconomicsI_working_version (1)

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Fiscal Policy in Details 113 However, the tax cuts also affect aggregate supply. The economists supporting the idea of deliberate influencing aggregate supply conclude that the aggregate supply curve moves to the right from AS to AS’ due to tax cuts. This is the domain of supply-side economics. The supply-side economists suggest three main reasons to explain the impact of reduced taxes on aggregate supply 2 : 1) Saving and investment. Reduced taxes will increase disposable incomes, increasing household saving. Tax reductions on businesses will also increase the profitability of investment. In brief, lower taxes will increase saving and investment, increasing the rate of capital accumulation. The size of the potential production capacity of the economy will grow more rapidly. 2) Work motivation. Reduced personal income tax rates also increase after-tax wages from work and thus increase work incentives. Many people not already in the labour force will offer their services because after-tax wages are higher. Those already in the labour force will want to work more hours and take fewer vacations. 3) Risk bearing. Lower tax rates encourage taking risks. Individuals and businesses will be more motivated and willing to risk their energies and financial capital on new production methods and new products when lower tax rates ensure a larger potential after-tax profit. These are the effects, through which reduced taxes move aggregate supply to the right from AS to AS’ in Figure 12.3. As a result real GDP rises with reduced inflation. P AD AD’ AS AS’ P2 P3 P1 Q1 Q2 Q3 Figure 12.3 Effects of fiscal policy on aggregate supply. In addition to the increase in aggregate demand increasing output and prices, reduced taxes induce the supply-side effects moving aggregate supply rightwards from AS to AS’. As a result an even larger output (Q 3 compared with Q 2 ) and reduced rise in price level (P 3 compared with P2) occur. Q 2 See McConnel – Brue [10]
114 Chapter 12 12.2. Non-Discretionary Fiscal Policy: Automatic Stabilisers In examining the fiscal policy we can conclude that fiscal policy is very demanding for its permanent vigilance by the government authorities. We can think that somebody must always check ceaselessly the overall performance of the economy and decide what kind of fiscal action should be taken. In fact, there are inherent automatic stabilising properties, which are built-in the economy. These measures work automatically when recession or too rapid growth of aggregate demand accelerating inflation occurs. The public budgets are determined by the business cycle. In the phase of contraction the public budgets tend to go into deficit whereas during expansion of output the budgets tend to go into surplus. The net taxes 3 are strongly procyclical, thus, when incomes and spending rise, tax collection automatically rises, and conversely. On the other hand, public transfers including unemployment benefits, tend to decrease during expansion and rise when economy experiences recession. However, we should mention that government consumption is not affected by the business cycle, because it is a part of discretionary fiscal policy. When the economy slows down, the budget deficit will normally increase, or its surplus will shrink or even shift into deficit. This automatic lowering of taxes amounts to an implicit fiscal expansion. Conversely, a better-than-expected economic performance reduces the budget deficit or increases the surplus because of enhanced tax income for the government, a contractionary fiscal policy of sorts. In the end, we see that exogenous shifts in private demand are automatically cushioned – if not completely offset – by shifts in public demand: these are so-called: automatic stabilisers (or built-in stabilisers).They work in the absence of any policy action: simply by enacting the budget as approved by the parliament, the government finds itself conducting a countercyclical fiscal policy, dampening both recessions and expansions. What are these automatic stabilisers? They are primarily the following: 1) Progressive tax system - automatic changes in tax receipts. The modern tax systems are based on progressive personal and corporate income taxes. (Progressive taxes mean that when income rises the average tax rate rises as well. This system is a useful automatic measure against the unexpected changes in economic performance. If total output (income) starts falling, tax receipts will automatically decline so that personal incomes and spending will be cushioned. This means that output will not decline as much as in case that the taxes would not decline. Conversely, a rise in tax revenues will reduce personal income, consumer spending and thus lower aggregate demand in inflationary times when upward spiral of prices and wages might accelerate. 2) Public transfers - unemployment insurance, welfare, and others. The social security system includes various types of welfare transfer payments cushioning people’s loss in income. Unemployment insurance is the typical example. As soon employees are laid off, they begin to obtain unemployment insurance. These types of payments work in countercyclical, stabilising way because they prevent economy against rapid fall in consumption demand during recessions. The other welfare 3 Net taxes refer to total taxes less transfers from the government to the private sector.
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Mendel University for Agriculture a
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24 Chapter 3 Changes in Aggregate D
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26 Chapter 3 Let’s assume, for no
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28 Chapter 3 A rise in productivity
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30 Chapter 3 P AD E AS 1. Equilibri
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32 Chapter 4 The main aim of human
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34 Chapter 4 4.2.1. Growth Accounti
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36 Chapter 4
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38 Chapter 5 The business cycle cou
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Page 131 and 132: The Phillips Curve 99 ∆P/P ∆W/W
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