Question

Suppose that President Trump cuts federal income taxes, and at the same time decreases government spending on schools and the environment. If the two actions offset each other exactly such that the fall in T = the fall in G, what will be the impact on U.S. output? Use the AA-DD model in your analysis.

In fact, according to current analyses, is the federal budget deficit expected to increase or decrease in FY2020?

When was the last time the U.S. federal government budget was balanced? Who was president at the time?

Answer 1

The output equation is given by

Y=C+I+G+NX

To include taxes, this equation can be written as

Y = C(Y - T) + I + G + NX

Assuming other factors remain constant, what we are saying is that T will fall- which will result in increased disposable income and hence-spending. On the other hand, G will also fall- which means while private citizens will spend more due to lowered taxes, the government will spend less and hence equate those out.

The net effect on US output depends on how much savings the public does (assuming other factors such as multipliers etc are same between public and private spending). If the public spends all the tax decrease, then the US output will remain same. But if the public saves a share of the tax decrease and spends only the rest, the net output will decrease. So, to summarize, the US output will be at equal to or less than the current output.

Based on current scenario, the federal budget deficit is expected to increase as the Tax Cuts and Jobs Act of 2017 reduced taxes. At the same time, there is no plan to reduce spending. The healthcare, defense and immigration act are all driving costs upwards. In fact, The Joint Committee on Taxation estimated the Act would add $1,456 billion total to the annual deficits (debt) over ten years.

The last time the US budget was balanced was in 2001 when the budget was in surplus. Bill Clinton was the president at that time.