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The Impact of Fiscal Policy on National Income1

Published online by Cambridge University Press:  07 November 2014

Harold M. Somers
Harold M. Somers*
Affiliation:
The University of Michigan
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Extract

The past decade has witnessed a growing recognition of the economic effects of government finance. Government expenditures and revenues, government borrowing and debt repayment are studied, not for their impact on the Treasury, but for their impact on the economy. It is recognized now more than ever before that each aspect of government finance may be used as an instrument of economic policy to influence the size of the nation's income or alter the character of the nation's output. At first the problems of the depression and now the necessities of the war have converted “government finance” into “fiscal policy.” The theory of fiscal policy, reborn in the depression, nurtured during the recovery and matured in the war, has become the handmaiden of the government official and the political economist.

In spite of the great amount of attention it has received, the theory of fiscal policy still lacks complete co-ordination of its various faculties and still suffers from frequent reversion to its childhood days. During the time of deep depression when the multiplier theory was developed it was taken for granted by many economists that deficits were the appropriate instrument for raising the level of national income. Since widespread unemployment and underemployment existed there was little need for differentiating real from money income, since a general rise in prices was not very likely and, in any case, was desirable. During the war, however, we wish to raise only the real income or the physical output, and then only the output of war materials, and keep down as much as possible the money national income and the price level. How must the theory of fiscal policy be changed as a result of these new objectives and altered conditions? And when the war is over will we have to resort to deficit-spending to prevent a depression? Are deficits, which were required to raise the level of national income, appropriate for maintaining a high level of national income? We must exercise the greatest care in answering these questions and we must guard against glibly applying some ready formula which we ourselves have carried over from the pre-war days of business depression. It is necessary first of all to examine the structure of fiscal policy (Part i) and trace through the interrelations among expenditures, taxation, borrowing, debt repayment, and national income (Part ii). Then we can see how fiscal policy may be used to achieve desired ends and avoid dangerous pitfalls during the war (Part iii) and in the post-war period (Part iv).

Type
Research Article
Information
Canadian Journal of Economics and Political Science/Revue canadienne de economiques et science politique , Volume 8 , Issue 3 , August 1942 , pp. 364 - 385
Copyright
Copyright © Canadian Political Science Association 1942

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Footnotes

1

A paper presented at the Annual Meeting of the Canadian Political Science Association, May 25, 1942. The writer is indebted to several members of the Round Table on Economic Theory for a number of valuable suggestions. This article forms part of a study made possible by a Fellowship of the Social Science Research Council.

References

2 As in the measures known as “the net contribution of the Federal Government to national buying power” or “the net income-increasing expenditure of the Federal Government.” For a description of the measures see Villard, H. H., Deficit Spending and the National Income (New York, 1941), Part iii.Google Scholar For a criticism of the treatment of taxation see Hansen, A. H., Fiscal Policy and Business Cycles (New York, 1941), p. 190 n.Google Scholar; and for a further discussion of this question see Hardy, C. O., “Fiscal Policy and the National Income” (American Economic Review, vol. XXXII, 03, 1942, pp. 103–10)Google Scholar and Angell, J. W., Investment and Business Cycles (New York and London, 1941), chap, xii and p. 325 n.Google Scholar

3 See Plumptre, A. F. W., “An Approach to War Finance” (Canadian Journal of Economics and Political Science, vol. VII, 02, 1941, pp. 1–12).CrossRefGoogle Scholar

4 See, for instance, Kahn, R. F., “The Relation of Home Investment to Unemployment” (Economic Journal, vol. XLI, 06, 1931, pp. 173–98)CrossRefGoogle Scholar; Mitnitzky, M., “The Effects of a Public Works Policy on Business Activity and Employment” (International Labour Review, vol. XXX, 10, 1934, pp. 435–56)Google Scholar; and Clark, J. M., Economics of Planning Public Works (Washington, 1935), chap. ix.Google Scholar

5 See Samuelson, Paul A., “Theory of Pump-Priming Re-examined” (American Economic Review, vol. XXX, 09, 1940, pp. 492–506).Google Scholar

6 With expenditures of 10, a marginal propensity to consume equal to 4/5 and a tax structure such that 50 per cent of increased income is diverted to the Treasury we have the following:

7 Replacing expenditures of 10 with expenditures of 30 in the above, we have:

8 Let α = the marginal propensity to consume

ty = the proportion of increased consumer outlay diverted to the Treasury in the form of taxation

Ty = the tax revenues

Xy = the initial government expenditures

Yy = the total increase in income

Dy = the deficit = Xy −Ty

Then we have the following sets of values:

From these we derive the following formulae:

9 These results are obtained by substituting Yy = 5 and α = 4/5 in the formulae for Xy , Ty , and Dy .

10 Let tc = the proportion of increased savings diverted to the Treasury in the form of taxation

Tc = the tax revenues

Xc = the initial government expenditures

Yc = the total increase in income

Dc = the deficit = Xc −Tc

Then we have the following sets of values:

From these we derive the following formulae:

11 These results are obtained by substituting Yc = 5 and α= 4/5 in the formulae for Xc , Tc , and Dc .

12 This may be seen by reference to the tables contained in Machlup, Fritz, “Period Analysis and Multiplier Theory” (Quarterly Journal of Economics, vol. LIV, 11, 1939, 1–27).CrossRefGoogle Scholar If the initial expenditure is unity and the marginal propensity to consume is 4/5 then the total increase in income will be 5. During the process of increasing the income, 1/5 of this amount, i.e. unity, will have “leaked out.” Just as the total increase in income is the sum of the infinite series, 1+4/5+(4/5)2 …, so the total leakage is the sum of the infinite series, 1/5 + 1/5(4/5) + 1/5(4/5)2+ …, or, 1/5{1+4/5+(4/5)2 + …}. This has a value of unity.

13 Let ts = the proportion of increased savings diverted to the Treasury in the form of taxation

Ts = the tax revenues

Xs = the initial government expenditures

Ys = the total increase in income

Ds = the deficit = Xs −Ts

Then we have the following sets of values:

From these we derive the following formulae:

14 These results are obtained by substituting Ys = 5 and α = 4/5 in the formulae for Xs , Ts , and Ds .

15 See Somers, Harold M., “Monetary Policy and the Theory of Interest” (Quarterly Journal of Economics, vol. LV, 05, 1941, pp. 488–507).CrossRefGoogle Scholar