Federal Economic Budget

Lesson for May 9th and May 12th

STEP 1 - Complete the Notes

Use this resource page and internet sources to complete the Federal Budget notes

Where the Money comes from:

1) Progressive taxes-take a higher percentage of income from higher incomes; e.g. Income tax

2) Regressive taxes-take a higher percentage of income from the lower income; e.g. sales tax, property tax

3) Proportional tax/flat tax- take the same percentage from everyone; e.g. Medicare

How the money is spent:

  1. Deficit- when revenues exceed expenditures
  2. Mandatory spending- government is obligated to pay these types of expenditure due to a pervious commitment, e.g. social security, interest on the debt
  3. Discretionary spending- items that require an act of Congress to authorize, may be revised up or down or eliminated completely if needed; e.g. defense, education, infrastructure
  4. Entitlements- programs that one automatically qualifies for based on some specific eligibility requirements; e.g. Social Security, unemployment compensation
  5. Debt- the accumulation of deficit spending

Fiscal Policy

•Using Taxes and Government spending to stabilize the economy.

•Controlled by the President and Congress

•Discretionary Fiscal Policy: Congress must take action (change the tax rates) in order for the action to be implemented.

•Automatic Stabilizers: Unemployment benefits, Progressive Tax System, these changes are implemented automatically to help the economy.

Types of Fiscal Policy


•Used to Fight a Recession




•Used to fight Inflation



Fiscal Policy and the Aggregate Demand-Aggregate Supply Model

Expansionary Fiscal Policy: expansionary is a $.50 word for growing. The purpose of expansionary policy is to make the economy grow. Fiscal means that it has to do with tax and spending policy – i.e. the government budgetary process. Therefore, expansionary fiscal policy concerns making the economy grow by using tax and spending policy.

  • budget deficits – expansionary fiscal policy is designed to spend more than the government takes in through taxes – so budget deficits are expected (and in fact by definition are required) to do expansionary fiscal policy.

Methods of Expansionary Policy

Increased Government Spending

The first method or tool that government has at its disposal is government spending. This is the same government spending that we used to find AE and AgD. If we increase government spending, (G), we expect that AE will rise, and AgD will shift to the right.

The graph below shows how when G increases (from G to G’), the AE curve rises (from AE to AE’) giving us a greater level of GDP (from GDP to GDP’). At the same time, that means that the level of GDP must be rising in the AgD-AS graph too (there can be only one level of GDP at any one time). Inthe lower graph, AgD (which also depends on G) shifts in response to the increase in G.

Tax Reductions

Tax deductions work differently, but the graph looks almost identical. When a tax cut is given (ceteris peribus – i.e. no matching decrease in G), the effect is felt through changes in the disposable income of individual consumers and businesses.

(decrease) T --> ­ (increase) YD --> (increase) ­ C --> (increase) AE --> ­(increase) GDP or Y

Here the tax cut gives people more disposable income (YD), which can be spent or saved (a portion of which is spent if MPC > 0), that shifts AE up and increases GDP

(decrease) T --> (increase) ­ profit margins --> (increase) ­ I --> (increase) ­AE --> (increase) ­GDP or Y

Tax Multiplier [-MPC/MPS]

•Remember, if the government decreases taxes, the result is not as great as a spending increase, since households will save a portion (MPS) of the tax cut.

•The Tax Multiplier = -MPC /MPS

•Example: If the MPC is .8 and the MPS is .2

•Spending Multiplier = 1/.2 or 5

•Tax Multiplier = -.8 /.2 or -4

Methods of Contractionary Policy

Contractionary Fiscal Policy

Contractionary means to shrink. So Contractionary Fiscal policy is designed to shrink the economy ((decrease) GDP). Why would you ever want to shrink GDP? We can see why in the AgD-AS graph. Look what happens to the level of PL as we shift from AgD’ to AgD’’. The PL falls as GDP shrinks. That means that one way to defeat inflation is to create a recession (falling GDP). Have we ever done this? Yes, we have.

Decreased Government Spending

(decrease) G --> (decrease) AE --> (decrease) GDP or Y --> (decrease) PL

A decrease in government spending causes the AE curve to shift down, leading to lower GDP and PL (decreases inflation)

Tax Increases

(increase) T --> (decrease) YD --> (decrease) C --> (decrease) AE --> (increase) GDP or Y --> (decrease) PL

Increases in taxes leave less money in the hands of individuals (YD), so they spend less ((decrease) C), and that causes AE to fall, creating less GDP. But the PL also falls

Watch the Hippocampus video - Surpluses, Deficits, and the National Debt

Click on US Politics and Government for AP. Scroll down to the Executive Branch. Click on Surpluses,Deficits, and the National Debt.

Financing of Deficits and Disposing of Surpluses

What do we do with the surpluses? Can we use them to pay off the debt? Generally, the answer is “no”. If we simply take that money and pay off debts by calling in government bonds, then money is injected into the system (Incomes rise). That would cause GDP to rise again – and PL with it.

Borrowing vs New Money

Borrowing from the Public: The government borrows from the public by issuing government bonds. When you buy a government bond, you’ve lent the government your money - which they promise to pay back with interest. You are acting as a bank. The more they borrow from you, the less you have in cash, on hand.

(increase) Government borrowing from the public --> (decrease) YD --> (decrease) C --> (decrease) AE --> (decrease) GDP or Y

It also does the same to businesses through consumers having less left to save:

(increase) Government borrowing from the public --> (decrease) YD --> (decrease) S --> (increase) i --> (decrease) I --> (decrease) AE --> ­(increase) GDP or Y --> (decrease) PL

Money Creation: printing money seems like a painless way to pay debt – but when you print money to pay off government’s bills, more money is in the hands of the public (which they can then spend). This causes C to rise – increasing AE and GDP.

Managing the Economy

1) Fiscal policy-government tax and spend to fix economic problems, e.g., $300 refund after 911

2) Monetary policy-FED controls the money supply to the same end

3) Supply-side- aka trickle down, reduce taxes on the money makers and they will create jobs

4) Keynesian- expand and contract the economy in response to the market

5) Monetarism-let the market fix itself

President and Congress:

Step 1

1st Monday in February, Pres submits a budget to Congress for the coming fiscal year (begins October 1), developed by OMB who has gathered information from the various cabinet departments and agencies and works to mesh their needs with the president’s political goals, he send cues to Congress for what he wants in both the areas of spending and taxation

Step 2

Congressional Budget Resolution

1) Questions executive branch officials based on OMB requests (House and Senate budget committees)

2) By April 15th, Congress “should” pass a budget resolution-levels of spending for each of 19 broad categories and the revenues that are expected- long range 5 year plans at least

3) Budget Authority/authorizations are the total amount of money that Congress will permit and agency to spend (may not actually spend this much money)

Step 3

1) Appropriations bills are passed based on the budget resolution. Often referred to as “omnibus” due to so many things being packed into one bill.

2) Continuing Resolutions (Oct 1st - ??): Congressional action that allows the agency to continue to function for a specific period of time until the appropriation bill is passed and signed by the President

3) Reconciliation bills may be offered. These revise original authorizations, may come from multiple committees and in the Senate cannot be filibustered. Some view this as a “loop hole” because often controversial budget items have been passed this way

Step 4: Execution and Review of Process

1) Fiscal Year begins (Oct 1st) all budgets must be approved by this date Agencies execute budgets (Oct 1st – Sept 30th ) all funding ends on Sept 30th even if new funding is not approved

2) General Accounting Agency (GAO) conducts audits, legislative oversight can come into play here

Click on US Politics and Government for AP. Scroll down to the Executive Branch. Click on the Office of Management and Budget.

Now watch this dialogue about the federal budget. Take notes on Handout #1 important points made by the participants.

The Federal Budget

Log in and Complete Both Quizzes

1) Debt, Deficit, and Surplus

2) Fiscal Policy

* No more than one partner


With the remaining time in class you will need to complete your AP Econ Review Packet or complete your review for the next Unit Exam (could possible have a larger than normal reward;))