Economic Policy: Chapter 18

 deficit  what the government takes in (taxes) and is less than what it spends (expenditures)  measured over a year  national debt  add up all of the deficits  since the start of USA

 national bonds  to raise more government funds  sells bonds to people (borrows money from the people)  must pay interest over time  paying back the interest is 3 rd largest part of the national budget  40% of our Gross Domestic Product  the value of all goods and services  PRODUCED in one year  within the borders of the nation

 increase taxes  cut spending  hurdles  war/security  pay to rebuild  pay to prevent future attacks  pay for military response

 increase taxes  cut spending  hurdles  recession/economic downturn  more safety net spending  less tax money coming in

 increase taxes  cut spending  Hurdles  natural disasters  destroys infrastructure  costs to rebuild

 Majoritarian Politics  everyone agrees inflation is bad  everyone agrees unemployment is bad  people care about their country as a whole as well as about themselves

 Majoritarian Politics  Voting behavior regarding economic conditions  strongly correlated at the national level  unemployment  Democrats  younger voters  inflation  Republicans  older voters  NOT strongly correlated at the individual level

 What Politicians Try to Do  Balancing Options and Making Choices  to slow inflation  raise interest rates  reduces how much people can borrow  mortgages  auto loans  less income for producers  entrepreneurs faced with lower income/profit  lay off workers = higher unemployment  to lower unemployment  do the opposite!

 What Politicians Try to Do  Just shifting the above is NOT so clean cut in the real world  economics is not a pure science  other factors enter into the equation  Ideology  Republican – cut inflation  Democratic – cut unemployment

 People want  lower taxes  increased spending  Politicians want  to keep people happy  to get reelected  Politicians can  lower taxes by cutting spending  increase spending by increasing taxes

 Presidents use economic advisors  advisors give different advice  Presidents get advisors whose advice they like!

 Monetarism  inflation is caused by too much money chasing too few goods  too much money is caused by the government printing in excess  role of government  increase printing money only at levels equal to growth of over-all economy  leave the rest of the economy alone  Conservative ideology

 Keynesianism  economic health comes from the ratio of what people spend and save  too much saving  less spending  increased unemployment  too much spending  increased demand  increased inflation

 Keynesianism  role of the government  create the right level of demand  demand too little, government pump in money  demand too great; restrict money  be very active in the economy  Liberal ideology

 Planned Economy  the forces of competition are not sufficient to regulate economy  government should command  wage controls to regulate unemployment  price controls to regulate inflation

 Planned Economy  industrial policy  direct investments to save industries  direct investments to convert outdated industries  Socialist ideology

 Supply-Side Tax Cuts  less government  cut taxes  people will save  people will invest  investments create new businesses  new businesses create more jobs  more people pay taxes  Tax revenue actually goes UP!  Conservative ideology

 Reaganomics  supply-side economics mixed with monetarism  cut size of government  cuts in some social spending  increases in military spending  creates huge budget deficits

 The Executive Branch “Troika”  Chairman of the Council of Economic Advisers (CEA)  CEA = three professional economists  A small staff to assist the professionals  Responsible to  TRY to forecast economic trends  Analyze emerging economic issues  Help prepare president’s economic report to Congress

 The Executive Branch “Troika”  Chairman of the Council of Economic Advisers (CEA)  Impartiality  Theory = completely impartial  Reality = presidents appoint members who he agrees with

 The Executive Branch “Troika”  Director of the Office of Budgetary Management (OMB)  Purpose of the OMB  prepare estimates of the spending of the various federal agencies  negotiate with other departments over budget  try to oversee that the legislative proposals of the various departments are in accord with the president’s vision

 The Executive Branch “Troika”  Director of the Office of Budgetary Management (OMB)  split personality  part impartial advisory organization  part partisan extension of presidential desires

 The Executive Branch “Troika”  Secretary of the Treasury  often comes from the business and finance world  argues on their behalf  provides  estimates of revenue (taxes)  predicts the ramifications of changing tax laws  meets with counterparts from other nations

 The Board of Directors of the FED  seven members  nominally independent of politics  appointed by president  primary function is to regulate  the supply of money (minting)  the value of money (interest rates)  Creates MONETARY POLICY – managing the economy via regulating money supply

 The Congress  Power to approve  taxes (House Ways and Means Committee)  expenditures (House Appropriations Committee)  Creates FISCAL POLICY – managing the economy via taxing and spending

 Summation  President needs assistance  to implement his economic policy  from many agencies

 Summation  Interest Group pressures  Protectionism  high tariffs/quotas  to restrict foreign imports  helps labor-intensive domestic industry  Free Trade  no tariffs  expands US exports  helps technology-intensive industry

 a document that states how much the government will  collect in taxes  spend for various programs  over the course of one year  FISCAL YEAR – time from one budget to next  Oct. 1 – Sept. 30

 Theory  first determine how much can be spent  THEN divide that amount among the various programs  Reality  first determine how much money will spent on programs  then add up the total

 Process  President submits budget to Congress (February)  Committees in Congress review the budget  Committees present BUDGET RESOLUTIONS to respective houses (May)  set overall ceiling for the budget  set ceiling for each major category within the overall budget

 Process  Chambers approve specific appropriations (Summer)  real impact is not that great  2/3 of budget is mandatory spending  Entitlements  Social welfare benefits  interest on bonds  President signs off on the budget

 responsive to  voters (Majoritarian politics)  Vote for me and I will keep taxes low (or lower!)  Vote for me and I will keep your favorite government program funded  interest group politics  client politics

 concern over deficit

 Balanced Budget Act of 1985 (Gramm-Rudman Act)  Five year plan  budget would get automatic cuts until the deficit was paid off  imposed a SEQUESTER  automatic spending cuts  based on set percents  on all federal programs  was a failure

 Budget Enforcement Act of 1990  Congress would pass a tax hike  A cap on discretionary spending would be imposed  pay as you go approach  raising spending in one sub-category would mean you MUST cut spending in that same sub-category

 What is a “fair” tax?  overall burden would be low  US tax rates are lower than other wealthy democracies  Majoritarian politics  everyone would pay something  Basically, YES!  Majoritarian politics

 What is a “fair” tax?  different rates for economic strata  Progressive taxes?  official rates are higher for higher incomes  tax deductions help rich more than they help the poor  Client politics

 The Rise of the Income Tax  The beginning  16 th Amendment  1913  Progressive?  Loopholes!

 Tax Reform Act of 1986  People want  small cuts in rates  big cuts in deductions

 Tax Reform Act of 1986  Businesses want  moderate raises in rates  Increased deductions  deductions are like money in the pocket  they do not have to be voted on yearly  last a long time  would go unnoticed

 Tax Reform Act of 1986  The people won  lower rates  less deductions  But since then … rates keep creeping up