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Role of the Government/Government Spending/Transfer Payments

Role of the Government/Government Spending/Transfer Payments

Author: Kate Eskra

Determine different roles of the government within the business cycle.

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Hi, welcome to Macroeconomics. This is Kate. This tutorial is on the role of the government, government spending, and transfer payments. As always my key terms are in red, and my examples are in green.

So in this tutorial we'll be talking about how it is that people disagree very much over the amount of government intervention. But most are going to agree that the government should provide, first of all, public goods, and second, some amount of stability to the economy. We'll go over those things. We'll talk about how government spending is the most important tool used when they're trying to stabilize the economy, and we'll look at how some automatic stabilizers go into effect automatically, as the economy begins to slow.

OK, so the question here to start out is, how much should the government be involved in our lives? Do you think we can get people to agree on this one? I don't think so. Obviously this is a topic with a whole lot of disagreement. I'm going to make some pretty general statements for a minute, so I apologize if you don't necessarily agree with this. But Democrats typically are going to be in favor of more government involvement in our economic lives, in terms of providing programs. This is going to mean paying higher taxes.

So Democrats there are typically, again, fans of, or proponents of our progressive income tax system that we have. And a progressive tax is one that where the tax increases with your income. So as you make more money, you actually pay a higher percentage of that income in taxes. So the state income tax system that we have is a progressive tax system.

And the reason it is is because it funds the idea of some type of income redistribution. Income redistribution is defined as any kind of government policy looks to try to provide economic relief to lower income earners by providing transfer payments, like welfare and other kinds of benefits. And the only way that those things are going to be funded is through our progressive tax system, by tax revenue generated from the higher income earners.

So Republicans, generally speaking, again, are going to disagree with that. They're going to like a little bit less government in our economic lives. So they understand that we will have fewer programs, but they want lower taxes. So they want more control of the individual in our economic lives.

All right, so that's the disagreement part. And we could talk about that all day, and no one would ever agree on it. But the fat of the matter is that most people to agree on a couple of things. First of all, most people in our country agree that the government does need to be involved, at least to provide some things. Two very good examples are things like national defense and police protection.

So the question is, why is it that our government needs to provide things like this? Could a private business provide them? While I'm sure there's some people would say yes, and make an argument for it, most of us can recognize that it would be pretty difficult. And there's two reasons why would be pretty difficult for a private business to provide national defense and police protection in our country.

First of all, there are shared benefits. Everybody enjoys the protection of national defense and police protection in a community. And it's also very difficult to exclude people from enjoying them. Even if you don't pay taxes in our country, you still enjoy the fact we have a military defending us.

So because of the fact that there are shared benefits in them, and it's hard to exclude people from enjoying them, they're known as public goods. And a public good-- here's your definition-- is typically provided or made available through the government. And it's made available through the government because of those characteristics I talked about, being non-rivalrous, or having shared consumption, and then being non-exclusive.

All right, another thing that people generally agree on is that the government should work to maintain some kind of stability in our economy. So we know that ups and downs in the economy will happen. We know that we have a business cycle where there's expansion and contractions in the short term, but the goal is really to reduce the length of the severity of recessions, to make sure we never have another Great Depression.

So when the economy begins to slow, the government really can use their government spending as a tool. They can spend money to try to simulate it, and to try to prevent it from worsening. So spending money in various ways can give people jobs, or just give people quick money to spend in the economy, to jump start it, get it going again.

And this is known as a counter-cyclical approach. So what that means is while the economy is slowing, contracting, or what we would call a recession, that's when the government would up their spending. Spending increases during recessions, and so that's going to basically mean that their government spending will be greater than the money they're taking in in tax revenue. And this is a time when the government is generally going to take on debt.

However, in this counter cyclical approach, then during a time period of expansion or recovery, that's when the spending can be decreased again, and when the tax revenue can actually be somewhat greater than the government spending. And that's the time when the government, in theory, should be repaying its debt.

So a lot of this government spending does need to be passed and approved by Congress, when it looks like the economy is slowing. So I listed a couple of examples for you that have been done in our nation's recent past. If we go back to the Bush administration, when it looked like the economy was entering into a recession, the Bush administration past some policies to send out stimulus checks. People were mailed out $300 as an individual, or $600 for a married couple. And then you got an additional-- actually I think it was $600 for an individual. You got an additional $300 for every child you had, up to so many children. The point of that was to give people money. Go out and spend it. If people go out and spend it, it can rejuvenate some businesses and pick the economy back up.

During the Obama administration, when we were in a recession, that administration passed policies to give a payroll tax cut. I think most people refer to as a tax holiday. So again, that's a less direct way to give people a little bit more money to go out and spend.

But there's other spending that actually happens automatically. I doesn't need to be approved by Congress. It just happens, and kicks in automatically as the economy begins to slow. And that's what we call our automatic stabilizers. These are government policies that go into effect automatically, as the economy slows, to try to counter this economics slowing. So payments are going to increase in a recession, and decrease as people get jobs again, as the economy grows and enters into that expansionary phase of the business cycle.

So some examples of this are some of the things I talked about in the very beginning of the tutorial, like transfer payments and welfare-- so things like unemployment compensation. As people start to lose jobs, they're going to automatically begin to qualify for these programs. And so these payments naturally will automatically kick in, and begin to increase as the economy is worsening.

Taxes are another example. We don't have to change the tax system, but as people start making less money they owe naturally less in taxes. As people are buying less, they're paying less in sales taxes. So those things are automatic. And what the point of them is is they're going to hopefully lessen the severity of an already slowing or contracting economy.

So in this tutorial we talked about yes, certainly people do disagree over the amount of government intervention in our lives, and our economic lives. But most agree that the government should provide public goods, and some stability to the economy. It's government spending that's really that most important tool used in stabilizing the economy. And finally we discussed a few of our automatic stabilizers that go into effect automatically, as the economy begins to slow. Thanks so much for listening. You have a great day.

Terms to Know
Automatic Stabilizer

Government policies that go into effect automatically as the economy slows to counter economic slowing; the payments increase in a recession and decrease with increased employment as an economy grows and enters into the expansionary phase.

Income Redistribution

Government policy that seeks to provide economic relief to low-income earners by providing welfare and other benefits (transfer payments) funded by tax revenue generated from high-income earners.

Progressive Tax

Tax that increases with income; income tax is an example.

Public Good

A good that is typically provided or made available through the government; the good is characterized as being both non-rivalrous and non-exclusive.