Federal deficit hits record $1.42 trillion -In 2009, the government collected $2
ID: 2496050 • Letter: F
Question
Federal deficit hits record $1.42 trillion -In 2009, the government collected $2.10 trillion in revenues, a drop of 16.6 percent while government spending jumped to $3.52 trillion, up 18.2 percent over 2008. The Obama administration has pledged to include a deficit-reduction plan in its 2011 budget, which will go to Congress in February 2010. Source: Charleston Daily Mail, October 16, 2009
If the deficit-reduction plan includes a cut in transfer payments and a rise in taxes of the same amount, how will this policy influence the budget deficit and real GDP?
Explanation / Answer
Cut in the transfer payments and rise in the taxes will reduce the budget deficit of the government as cut in the transfer payment will cut government spending and ride in the taxes will increase the tax revenue of the government. Thus, there will be reduction in budget deficit.
Cut in the Transfer payment will lead to decline in the aggregate demand of the economy as it will reduce the disposable income in the hands of the people. This reduction in the aggregate demand will be a multiple of the fall in the transfer payments. Rise in the taxes will also have a similar impact as the cut in the transfer payment as it will also reduce disposable income. Thus, there will be a decline in real GDP by a multiple amount of the fall in the Transfer payment and rise in the taxes.
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