ECO 372 Week 4 Fiscal Policy Example

The 2025 Budget Law Seen From a Michigan Factory: Tax Changes, Spending Cuts, Multipliers, Automatic Stabilizers and the Deficit, and What They Mean for Demand and Investment

[Student Name]

University of Phoenix

ECO/372: Principles of Macroeconomics

Week 4 Assignment

[Instructor Name]

[Date]

Lakeview Precision Components is a composite written for a model paper; budget provisions, projections and research findings come from the sources listed and are stated generally.

In July 2025, Congress passed and the President signed a broad budget reconciliation law that made permanent most of the individual income tax cuts first enacted in 2017, restored full first-year expensing for business equipment and domestic research spending, added new deductions for some workers and car buyers and reduced future federal spending on Medicaid and food assistance. The composite Grand Rapids parts supplier wanted to know what the law would mean for car demand and for its own plan to buy a $6 million machining line. Fiscal policy reaches a factory through its customers' paychecks, its own tax bill and the interest rates it pays, so each channel needs to be traced. This paper analyzes the law through those channels.

Two Kinds of Fiscal Policy

Discretionary fiscal policy consists of laws that change spending or taxes. Automatic stabilizers work without new laws: in a downturn, income tax receipts fall and unemployment benefits rise, cushioning household incomes; in a boom, the reverse happens. Automatic stabilizers act quickly and require no legislative debate, which makes them valuable in recessions (Mankiw, 2021).

What the Law Changed

For households, the law kept income tax rates and the larger standard deduction from 2017 in place permanently, avoiding a scheduled tax increase. It added temporary deductions for some tip and overtime income and for interest on loans to buy new vehicles assembled in the United States. For businesses, it restored 100 percent bonus depreciation for qualifying equipment and immediate deduction of domestic research costs. On the spending side, it reduced future federal spending on Medicaid and nutrition assistance, mainly through eligibility and work requirements phased in over several years.

Effects on Demand Through Multipliers

Because the household tax cuts mostly extended existing law, they avoided a reduction in disposable income rather than adding new income, so their effect on demand relative to the prior year is modest. The new deductions add some spending power, concentrated among workers with tips or overtime and new car buyers. The spending reductions, phased in later, will lower demand among lower-income households, who tend to spend most of each dollar. Research suggests that multipliers for transfers to lower-income households are relatively large, while multipliers for tax cuts to higher-income households are smaller. Ramey (2011) reviewed evidence on government purchases and found multipliers mostly between about 0.8 and 1.5, with substantial uncertainty.

The Car Loan Deduction

The deduction for interest on loans for new U.S.-assembled vehicles directly affects Lakeview's market. For a household financing a $45,000 vehicle at 7 percent, first-year interest of about $3,150, deductible at a 22 percent tax rate, saves roughly $690 in taxes. That modest saving could tilt some purchases toward domestically assembled vehicles that use parts like Lakeview's, though the effect on total car sales is likely small.

Supply-Side Effects on Investment

Full expensing lets firms deduct the cost of equipment in the year of purchase rather than over its useful life. For Lakeview's $6 million machining line, that means a deduction of $6 million in the first year, saving about $1.3 million of federal tax up front rather than spreading it over seven years. The present value of the tax savings rises, lowering the effective cost of investment. Romer and Romer (2010) found that tax changes have large effects on output, with tax increases strongly contractionary, consistent with the view that business tax provisions can influence investment and growth.

Deficits and Debt

Before the law, the Congressional Budget Office projected that federal debt held by the public would rise from about 100 percent of gross domestic product in 2025 to about 118 percent by 2035 (Congressional Budget Office, 2025). Nonpartisan estimates indicated that the law would add several trillion dollars to deficits over a decade, raising debt further. Larger deficits require more borrowing.

Crowding Out

When the government borrows more, it competes with private borrowers for savings, which can raise interest rates and reduce private investment, a process called crowding out. If long-term rates rise, Lakeview's loan for the machining line costs more, offsetting part of the expensing benefit. The size of crowding out depends on how much savings are available, including from abroad, and on how the Federal Reserve responds.

Who Gains and Who Loses

A law of this size redistributes as well as stimulates. Higher-income households gain most in dollars from the permanent tax rate extensions, workers with tips or overtime gain from the new deductions and businesses that invest heavily gain from expensing. Lower-income households that rely on Medicaid or food assistance will see benefits reduced as the spending changes take effect. State governments, which share Medicaid costs, may face pressure on their own budgets. Analyses by nonpartisan groups found that the combined effect raised after-tax incomes on average for higher-income groups and reduced resources for many lower-income households once spending changes were counted.

Lags and Timing

Fiscal policy acts with lags: recognizing a problem, passing a law and the time for spending and tax changes to affect behavior. The 2025 law phases in its spending cuts over several years, so its demand effects will unfold gradually. Its business provisions apply to investments placed in service after specific dates, encouraging firms to act soon.

Lessons for Lakeview

Lakeview decided to buy the machining line in 2025 to capture full expensing, financed at a fixed rate to protect against rising long-term rates. It expects car demand to be supported modestly by the vehicle loan deduction but watches for weakness among lower-income buyers as spending reductions phase in.

Conclusion

The 2025 budget law used several fiscal tools at once: extending tax cuts, adding targeted deductions, encouraging investment through expensing and reducing future spending on assistance programs. Its short-run demand effects are modest and uneven, its supply-side effects favor investment like Lakeview's and its addition to deficits raises the risk of crowding out. Tracing each channel turns a long law into specific effects a business can plan around.

References

Congressional Budget Office. (2025). The budget and economic outlook: 2025 to 2035. https://www.cbo.gov/publication/60870

Mankiw, N. G. (2021). Principles of macroeconomics (9th ed.). Cengage.

Ramey, V. A. (2011). Can government purchases stimulate the economy? Journal of Economic Literature, 49(3), 673-685. https://doi.org/10.1257/jel.49.3.673

Romer, C. D., & Romer, D. H. (2010). The macroeconomic effects of tax changes: Estimates based on a new measure of fiscal shocks. American Economic Review, 100(3), 763-801. https://doi.org/10.1257/aer.100.3.763