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Chapter EighteenChapter Eighteen

Economic PolicyEconomic Policy

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Politics and EconomicsPolitics and Economics

DeficitDeficit: when expenditures exceed : when expenditures exceed revenuesrevenues

National debtNational debt: the total amount of : the total amount of deficits the government has accrueddeficits the government has accrued

Debt is currently about 40% of Gross Debt is currently about 40% of Gross Domestic Product (GDP), the total of all Domestic Product (GDP), the total of all goods and services produced.goods and services produced.

To reduce the debt, politicians either To reduce the debt, politicians either advocate cutting spending (conservative), advocate cutting spending (conservative), or raising taxes (liberal)or raising taxes (liberal)

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Figure 18.1 Federal Budget Deficit (or Figure 18.1 Federal Budget Deficit (or Surplus), FY 1960–2008 in Billions of Surplus), FY 1960–2008 in Billions of

CONSTANT FY 2003 DollarsCONSTANT FY 2003 Dollars(President’s Proposals)(President’s Proposals)

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UncertaintyUncertainty

Economic forecasts are always Economic forecasts are always uncertain –September 11uncertain –September 11thth attacks attacks and subsequent military actions had and subsequent military actions had significant economic implicationssignificant economic implications

When the nation is in recession, tax When the nation is in recession, tax revenues decrease and spending on revenues decrease and spending on social programs may increasesocial programs may increase

See p.487See p.487

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Figure 18.2: Bad Economic Figure 18.2: Bad Economic GuessesGuesses

National Journal (January 30, 1999), 251.

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The Politics of ProsperityThe Politics of Prosperity

Voters see connections between the Voters see connections between the nation as a whole and their own nation as a whole and their own situationssituations

Voting behavior and economic Voting behavior and economic conditions are not always correlated conditions are not always correlated at the national and individual levels—at the national and individual levels—people do not always vote in line people do not always vote in line with their pocketbookswith their pocketbooks

See p.489See p.489

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Politicians and the EconomyPoliticians and the Economy

Elected officials are tempted to take Elected officials are tempted to take a short-term view of the economy a short-term view of the economy and satisfy the self-regarding voterand satisfy the self-regarding voter

Government does not know how to Government does not know how to produce all desirable outcomesproduce all desirable outcomes

Economic pressures are often Economic pressures are often interrelatedinterrelated

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Ideology and the EconomyIdeology and the Economy

Ideology plays large role in shaping Ideology plays large role in shaping policy choicespolicy choices

Democrats tend to want to reduce Democrats tend to want to reduce unemploymentunemployment

Republicans tend to want to reduce Republicans tend to want to reduce inflationinflation

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The Politics of Taxing and The Politics of Taxing and SpendingSpending

Majoritarian politics yields conflicting Majoritarian politics yields conflicting recommendations: lower taxes, less recommendations: lower taxes, less debt, new programs are all wanteddebt, new programs are all wanted

Meaningful tax cuts are politically Meaningful tax cuts are politically difficult; new programs tend to be difficult; new programs tend to be more popular with politicians more popular with politicians

See p.490See p.490

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Figure 18.4 Tax Figure 18.4 Tax Burdens in Burdens in Democratic Democratic NationsNations(Taxes as a (Taxes as a Percentage of Percentage of IncomeIncomeof a Family with of a Family with Two Children)Two Children)

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MonetarismMonetarism

MonetarismMonetarism: inflation occurs when : inflation occurs when there is too much money chasing too there is too much money chasing too few goods few goods

Monetarists advocate increasing the Monetarists advocate increasing the money supply at a rate about equal money supply at a rate about equal to economic growth and then letting to economic growth and then letting the free market operatethe free market operate

See p.491See p.491

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KeynesianismKeynesianism

View comes from John Maynard Keynes, View comes from John Maynard Keynes, an English economistan English economist

Assumes that the health of the economy Assumes that the health of the economy depends on what fraction of their incomes depends on what fraction of their incomes people save or spendpeople save or spend

When demand is too low, the gov’t should When demand is too low, the gov’t should pump money into the economy by pump money into the economy by spending more than it collects in taxesspending more than it collects in taxes

See p.491See p.491

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Supply-Side Tax CutsSupply-Side Tax Cuts

There is a need for less government There is a need for less government interference in the market and lower interference in the market and lower taxes taxes

Lower taxes would create incentives Lower taxes would create incentives for investmentfor investment

Greater economic productivity will Greater economic productivity will then produce more tax revenuethen produce more tax revenue

See p.491-492See p.491-492

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ReaganomicsReaganomics

Combination of monetarism, supply-Combination of monetarism, supply-side tax cuts, and domestic budget side tax cuts, and domestic budget cuttingcutting

Military spending increased sharplyMilitary spending increased sharply Money supply controlled—cut Money supply controlled—cut

inflation but allowed interest rates to inflation but allowed interest rates to riserise

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ReaganomicsReaganomics

Personal income taxes were cut, but Personal income taxes were cut, but Social Security taxes were increasedSocial Security taxes were increased

Large deficits were incurred, Large deficits were incurred, dramatically increasing size of dramatically increasing size of national debtnational debt

Stimulated economy—unemployment Stimulated economy—unemployment decreased, business activity increaseddecreased, business activity increased

See p.492-493See p.492-493

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Economic Policy MakingEconomic Policy Making

Council of Economic AdvisersCouncil of Economic Advisers: : professional economists sympathetic to professional economists sympathetic to the president’s view of economicsthe president’s view of economics

Office of Management and BudgetOffice of Management and Budget: : prepares estimates of amounts to be spent prepares estimates of amounts to be spent by federal government agencies; by federal government agencies; negotiates department budgetsnegotiates department budgets

Secretary of the Treasury: Secretary of the Treasury: reflects the reflects the point of view of the financial communitypoint of view of the financial community

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The Federal Reserve BoardThe Federal Reserve Board

See p.494See p.494 Members are appointed by the Members are appointed by the

president, confirmed by the Senate; president, confirmed by the Senate; serve a nonrenewable fourteen-year serve a nonrenewable fourteen-year term; removable for causeterm; removable for cause

Somewhat independent of both the Somewhat independent of both the president and Congresspresident and Congress

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The Federal Reserve BoardThe Federal Reserve Board

**Regulates the supply of money **Regulates the supply of money (both in circulation and in bank (both in circulation and in bank deposits) and price of money (in the deposits) and price of money (in the form of interest rates)form of interest rates)

Sets Sets monetary policymonetary policy: the effort to : the effort to shape the economy by controlling shape the economy by controlling the amount of money and bank the amount of money and bank deposits and the interest rates deposits and the interest rates charged for moneycharged for money

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Chairman of the FedBen Bernanke

CongressCongress The most important part of the economic The most important part of the economic

policy making machinery is Congress.policy making machinery is Congress. It must approve all taxes and almost all It must approve all taxes and almost all

expenditures expenditures There can be no wage or price controls without There can be no wage or price controls without

its consent its consent It has the ability to alter the policy of the Fed It has the ability to alter the policy of the Fed

by threatening to pass laws to reduce its by threatening to pass laws to reduce its powers.powers.

The decisions Congress makes about how high The decisions Congress makes about how high taxes should be and how much money the taxes should be and how much money the gov’t should spend create gov’t should spend create fiscal policyfiscal policy..

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The BudgetThe Budget

BudgetBudget: a document that announces : a document that announces how much the government will collect how much the government will collect in taxes and spend in revenues and in taxes and spend in revenues and how those expenditures will be how those expenditures will be allocated among various programsallocated among various programs

Fiscal yearFiscal year: time period covered by : time period covered by the budget, running from October 1 to the budget, running from October 1 to September 30 of the following yearSeptember 30 of the following year

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Congressional Budget Act of Congressional Budget Act of 19741974

President submits budgetPresident submits budget House and Senate budget House and Senate budget

committees analyze the budget, with committees analyze the budget, with the Congressional Budget Officethe Congressional Budget Office

Each committee proposes to its Each committee proposes to its house a budget resolution that sets a house a budget resolution that sets a total budget ceiling and ceilings for total budget ceiling and ceilings for each of several spending areaseach of several spending areas

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Congressional Budget Act of Congressional Budget Act of 19741974

Congress considers appropriations bills Congress considers appropriations bills and sees whether they are congruent and sees whether they are congruent with the budget resolutionwith the budget resolution

Appropriations bills cannot make big Appropriations bills cannot make big changes in the budget because changes in the budget because approximately 2/3 of government approximately 2/3 of government spending is on spending is on entitlementsentitlements (include (include Social Security and Medicare payments, Social Security and Medicare payments, veterans’ benefits, food stamps, etc.)veterans’ benefits, food stamps, etc.)

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Gramm-Rudman (Balanced Gramm-Rudman (Balanced Budget) Act of 1985Budget) Act of 1985

Called for automatic cuts from 1986–Called for automatic cuts from 1986–1991, until the federal deficit 1991, until the federal deficit disappeareddisappeared

If there was a lack of agreement between If there was a lack of agreement between the president and Congress on the total the president and Congress on the total spending level, there would be automatic spending level, there would be automatic across-the board cut (a across-the board cut (a sequestersequester))

The president and Congress still found The president and Congress still found ways to increase spending, howeverways to increase spending, however

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1990 Budget Strategy1990 Budget Strategy

Congress voted a tax increase and Congress voted a tax increase and the Budget Enforcement Act capped the Budget Enforcement Act capped non-entitlement (discretionary) non-entitlement (discretionary) fundingfunding

If entitlement spending increased, If entitlement spending increased, there had to be cuts in discretionary there had to be cuts in discretionary spending or taxes had to be raisedspending or taxes had to be raised

Expired in 2001, but may be re-Expired in 2001, but may be re-instatedinstated

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Levying TaxesLevying Taxes

Most revenue was derived from Most revenue was derived from tariffs until ratification of the tariffs until ratification of the Sixteenth Amendment (1913)Sixteenth Amendment (1913)

Taxes then varied with war (high) Taxes then varied with war (high) and peace (low)and peace (low)

Offsetting high tax rates were Offsetting high tax rates were various deductions or exemptionsvarious deductions or exemptions

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Levying TaxesLevying Taxes

Tax Reform Act of 1986-instead of high Tax Reform Act of 1986-instead of high rates with big deductions, low rates with rates with big deductions, low rates with smaller deductions (didn’t actually work smaller deductions (didn’t actually work b/c rates went right back up)b/c rates went right back up)

George H.W. Bush and Clinton increased George H.W. Bush and Clinton increased tax rates, keeping deductions lowtax rates, keeping deductions low

Balanced budget switched policy Balanced budget switched policy debates to tax cuts, but Social Security debates to tax cuts, but Social Security and Medicare policy problems remainand Medicare policy problems remain

See p.501 & 503See p.501 & 503