CHAPTER SUMMARY
1. Government outlays are government purchases of goods and services, transfers, and net interest. To pay for them, the government collects revenue by four main types of taxes: personal taxes, contributions for social insurance, taxes on production and imports, and corporate taxes.
2. The government budget deficit equals government outlays minus tax revenues and indicates how much the government must borrow during the year. The primary government budget deficit is the total deficit less net interest payments. The primary deficit indicates by how much the cost of current programs (measured by current government purchases and transfers) exceeds tax revenues during the year.
3. Fiscal policy affects the economy through its effects on aggregate demand, government capital formation, and incentives.
4. Increases or decreases in government purchases affect aggregate demand by changing desired national saving and shifting the IS curve. If Ricardian equivalence doesn't hold, as Keynesians usually argue, changes in taxes also affect desired national saving, the IS curve, and aggregate demand. Automatic stabilizers in the government's budget allow spending to rise or taxes to fall automatically in a recession, which helps cushion the drop in aggregate demand during a recession. The full-employment deficit is what the deficit would be— given current government spending programs and tax laws—if the economy were at full employment. Because of automatic stabilizers that increase spending and reduce taxes in recessions, the actual deficit rises above the full-employment deficit in recessions.
5. Government capital formation contributes to the productive capacity of the economy. Government capital formation includes both investment in physical capital (roads, schools) and investment in human capital (education, child nutrition). Official measures of government investment include only investment in physical capital.
6. The average tax rate is the fraction of total income paid in taxes, and the marginal tax rate is the fraction of an additional dollar of income that must be paid in taxes. Changes in average tax rates and changes in marginal tax rates have different effects on economic behavior. For example, an increase in the average tax rate (with no change in the marginal tax rate) increases labor supply, but an increase in the marginal tax rate (with no change in the average tax rate) decreases labor supply.
7. Policymakers must be concerned about the fact that taxes induce distortions, or deviations in economic behavior from that which would have occurred in the absence of taxes. One strategy for minimizing distortions is to hold tax rates approximately constant over time (tax rate smoothing), rather than alternating between high and low tax rates.
8. The national debt equals the value of government bonds outstanding. The government budget deficit, expressed in nominal terms, equals the change in the government debt. The behavior of the debt-GDP ratio over time depends on the ratio of the deficit to nominal GDP, the ratio of total debt to nominal GDP, and the growth rate of nominal GDP.
9. Deficits are a burden on future generations if they cause national saving to fall because lower national saving means that the country will have less capital and fewer foreign assets than it would have had otherwise. Ricardian equivalence indicates that a deficit caused by a tax cut won't affect consumption and therefore won't affect national saving. In the Ricardian view, a tax cut doesn't affect consumption because the increase in consumers' current income arising from the tax cut is offset by the prospect of increased taxes in the future, leaving consumers no better off. In theory, Ricardian equivalence still holds if the government debt isn't repaid by the current generation, provided that people care about the well-being of their descendants and thus choose not to consume more at their descendants' expense.
10. Ricardian equivalence may not hold—and thus tax cuts may affect national saving—if (1) borrowing constraints prevent some people from consuming as much as they want to; (2) people are shortsighted and don't take expected future changes in taxes into account in their planning; (3) people do not leave bequests; or (4) taxes aren't lump-sum. The empirical evidence on Ricardian equivalence is mixed.
11. Deficits are linked to inflation when a government finances its deficits by printing money. The amount of revenue that the government raises by printing money is called seignorage. The real value of seignorage equals the inflation rate times the real money supply. Increasing the inflation rate doesn't always increase the government's real seignorage because higher inflation causes the public to hold a smaller real quantity of money. Attempts to push the collection of seignorage above its maximum can lead to hyperinflation.
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