|Originally posted by doublec4:|
How is the federal governments revenues and expenditures affected by changes in output, unemployment, inflation, and interest rates? And how is the federal budget deficit affected by an increase in economic activity and domestic income?
That is a political hot potato...and a WOPPER of question to try to answer in one post. People have wrtten entire books on the subject.
OK, short answer, GNP=C+I+G+(X-M) [Gross National Product= consumption+Investment+Govt+(exports-imports)]
Long version, The entire crux of the GOP mantra is that government revenue actually increases when you lower taxes. Liberals will violently disagree but the reality does not lie. Here is the broad picture; Households owe factors of production to business. Likewise, business is owned by households. They are co-dependent. Business receives investment from households and business, in return, provides goods and services to households. When output is balanced with input (production with investment), unemployment remains low, inflation remains low and interest rates remain low. In this case, revenues and expenditures are predictable (for the most part; war, natural disasters, etc. are estimated). Now as we know, disposable income is equal to consumption + interest paid by the consumer and savings. And disposable income is Personal income less personal income tax. PI-PIT=DI. For governments, the goal is to increase revenues so to do this they want to make MORE DI available to households. to do this you can increase PI (the liberal's plan, increase minimum wage blah blah blah) or you can reduce PIT (the smart plan). By reducing PIT you reduce the costs of goods and services, increase consumption, and stimulate investment. This results in lower cost goods and services and increased output. increased output is taxable and results in even higher government revenue due tot he fact that business pays higher taxes that individuals and business is less likely to cheat on their taxes. Now keep in mind that output is exports - imports. Remember we talked last time about ways governments deal with that...tariffs, subsidies, etc.
Hence, output goes up, Govt Revenue goes up and expenditure goes up too. Wait,make that exp goes down. I think based on your question you are studying a classical Macro economics class so say down on your test. You'll learn just the opposite about 3 classes from now.
Unemployment increases as consumption and investment falls off. BTW, I am assuming we are talking about "competitive employment" here. So it is obvious that government revenues will fall too. The irony is that in many cases the government will tap into their debt (increasing it) to stimulate employment in an attempt to stimulate consumption and in turn to stimulate more revenue. This is an endless cycle that only increases debt and in the long run is not sustainable. In the 1930s FDR created a wealfare state with vast government works projects whcih we are still paying for. The phillips curve explains the relationship between unemployment and inflation. And the isoquant curve shows that increases in output at a known cost. Cost is known when employment is known. I don't want to go off on a political rant about unemployment so suffice it to say that:
when unemployment goes up, Government revenue goes down AND expenditure goes up! <----more economic activity means more debt! Not because it is necessary but because...oh God, another day. Just know it does.
Revenues and expenditures as they relate to interest rates are harder to predict especially because I am not sure whether you are talking about money interest or real interest. The classical model tells us that as interest rates increase bank lending rates increase and savings increases. Sounds great right? Well, there is one small problem, as the cost of capital increases borrowing drops off.
Can the use of monetary policy counter the "crowding out" effect?
Delta + M --> Delta - i --> Delta + I --> Delta + Y
You'ld never be able to lower interest rates enough if investment demand is sloped too steaply.
Use Fiscal Policy. S+T=I+G <----learn it, live it, know it
[This message has been edited by Toddster (edited 07-28-2006).]