1 Chapter Eighteen Economic Policy

2 Politics and Economics Deficit: when expenditures exceed revenues Deficit: when expenditures exceed revenues National debt: the total amount of deficits the government has accrued National debt: the total amount of deficits the government has accrued Debt is currently about 40% of Gross Domestic Product (GDP), the total of all goods and services produced. Debt is currently about 40% of Gross Domestic Product (GDP), the total of all goods and services produced. To reduce the debt, politicians either advocate cutting spending (conservative), or raising taxes (liberal) To reduce the debt, politicians either advocate cutting spending (conservative), or raising taxes (liberal)

3 Figure 18.1 Federal Budget Deficit (or Surplus), FY 1960–2008 in Billions of CONSTANT FY 2003 Dollars (President’s Proposals)

4 Uncertainty Economic forecasts are always uncertain – September 11 th attacks and subsequent military actions had significant economic implications Economic forecasts are always uncertain – September 11 th attacks and subsequent military actions had significant economic implications When the nation is in recession, tax revenues decrease and spending on social programs may increase When the nation is in recession, tax revenues decrease and spending on social programs may increase See p.487 See p.487

5 Figure 18.2: Bad Economic Guesses National Journal (January 30, 1999), 251.

6 The Politics of Prosperity Voters see connections between the nation as a whole and their own situations Voters see connections between the nation as a whole and their own situations Voting behavior and economic conditions are not always correlated at the national and individual levels—people do not always vote in line with their pocketbooks Voting behavior and economic conditions are not always correlated at the national and individual levels—people do not always vote in line with their pocketbooks See p.489 See p.489

7 Politicians and the Economy Elected officials are tempted to take a short-term view of the economy and satisfy the self-regarding voter Elected officials are tempted to take a short-term view of the economy and satisfy the self-regarding voter Government does not know how to produce all desirable outcomes Government does not know how to produce all desirable outcomes Economic pressures are often interrelated Economic pressures are often interrelated

8 Ideology and the Economy Ideology plays large role in shaping policy choices Ideology plays large role in shaping policy choices Democrats tend to want to reduce unemployment Democrats tend to want to reduce unemployment Republicans tend to want to reduce inflation Republicans tend to want to reduce inflation

9 The Politics of Taxing and Spending Majoritarian politics yields conflicting recommendations: lower taxes, less debt, new programs are all wanted Majoritarian politics yields conflicting recommendations: lower taxes, less debt, new programs are all wanted Meaningful tax cuts are politically difficult; new programs tend to be more popular with politicians Meaningful tax cuts are politically difficult; new programs tend to be more popular with politicians See p.490 See p.490

10 Figure 18.4 Tax Burdens in Democratic Nations (Taxes as a Percentage of Income of a Family with Two Children)

11 Monetarism Monetarism: inflation occurs when there is too much money chasing too few goods Monetarism: inflation occurs when there is too much money chasing too few goods Monetarists advocate increasing the money supply at a rate about equal to economic growth and then letting the free market operate Monetarists advocate increasing the money supply at a rate about equal to economic growth and then letting the free market operate See p.491 See p.491

12 Keynesianism View comes from John Maynard Keynes, an English economist View comes from John Maynard Keynes, an English economist Assumes that the health of the economy depends on what fraction of their incomes people save or spend Assumes that the health of the economy depends on what fraction of their incomes people save or spend When demand is too low, the gov’t should pump money into the economy by spending more than it collects in taxes When demand is too low, the gov’t should pump money into the economy by spending more than it collects in taxes See p.491 See p.491

13 Supply-Side Tax Cuts There is a need for less government interference in the market and lower taxes There is a need for less government interference in the market and lower taxes Lower taxes would create incentives for investment Lower taxes would create incentives for investment Greater economic productivity will then produce more tax revenue Greater economic productivity will then produce more tax revenue See p See p

14 Reaganomics Combination of monetarism, supply-side tax cuts, and domestic budget cutting Combination of monetarism, supply-side tax cuts, and domestic budget cutting Military spending increased sharply Military spending increased sharply Money supply controlled—cut inflation but allowed interest rates to rise Money supply controlled—cut inflation but allowed interest rates to rise

15 Reaganomics Personal income taxes were cut, but Social Security taxes were increased Personal income taxes were cut, but Social Security taxes were increased Large deficits were incurred, dramatically increasing size of national debt Large deficits were incurred, dramatically increasing size of national debt Stimulated economy—unemployment decreased, business activity increased Stimulated economy—unemployment decreased, business activity increased See p See p

16 Economic Policy Making Council of Economic Advisers: professional economists sympathetic to the president’s view of economics Council of Economic Advisers: professional economists sympathetic to the president’s view of economics Office of Management and Budget: prepares estimates of amounts to be spent by federal government agencies; negotiates department budgets Office of Management and Budget: prepares estimates of amounts to be spent by federal government agencies; negotiates department budgets Secretary of the Treasury: reflects the point of view of the financial community Secretary of the Treasury: reflects the point of view of the financial community

17 The Federal Reserve Board See p.494 See p.494 Members are appointed by the president, confirmed by the Senate; serve a nonrenewable fourteen-year term; removable for cause Members are appointed by the president, confirmed by the Senate; serve a nonrenewable fourteen-year term; removable for cause Somewhat independent of both the president and Congress Somewhat independent of both the president and Congress

18 The Federal Reserve Board **Regulates the supply of money (both in circulation and in bank deposits) and price of money (in the form of interest rates) **Regulates the supply of money (both in circulation and in bank deposits) and price of money (in the form of interest rates) Sets monetary policy: the effort to shape the economy by controlling the amount of money and bank deposits and the interest rates charged for money Sets monetary policy: the effort to shape the economy by controlling the amount of money and bank deposits and the interest rates charged for money

19 Chairman of the Fed Ben Bernanke

Congress The most important part of the economic policy making machinery is Congress. The most important part of the economic policy making machinery is Congress. It must approve all taxes and almost all expenditures It must approve all taxes and almost all expenditures There can be no wage or price controls without its consent There can be no wage or price controls without its consent It has the ability to alter the policy of the Fed by threatening to pass laws to reduce its powers. It has the ability to alter the policy of the Fed by threatening to pass laws to reduce its powers. The decisions Congress makes about how high taxes should be and how much money the gov’t should spend create fiscal policy. The decisions Congress makes about how high taxes should be and how much money the gov’t should spend create fiscal policy. 20

21 The Budget Budget: a document that announces how much the government will collect in taxes and spend in revenues and how those expenditures will be allocated among various programs Budget: a document that announces how much the government will collect in taxes and spend in revenues and how those expenditures will be allocated among various programs Fiscal year: time period covered by the budget, running from October 1 to September 30 of the following year Fiscal year: time period covered by the budget, running from October 1 to September 30 of the following year

22 Congressional Budget Act of 1974 President submits budget President submits budget House and Senate budget committees analyze the budget, with the Congressional Budget Office House and Senate budget committees analyze the budget, with the Congressional Budget Office Each committee proposes to its house a budget resolution that sets a total budget ceiling and ceilings for each of several spending areas Each committee proposes to its house a budget resolution that sets a total budget ceiling and ceilings for each of several spending areas

23 Congressional Budget Act of 1974 Congress considers appropriations bills and sees whether they are congruent with the budget resolution Congress considers appropriations bills and sees whether they are congruent with the budget resolution Appropriations bills cannot make big changes in the budget because approximately 2/3 of government spending is on entitlements (include Social Security and Medicare payments, veterans’ benefits, food stamps, etc.) Appropriations bills cannot make big changes in the budget because approximately 2/3 of government spending is on entitlements (include Social Security and Medicare payments, veterans’ benefits, food stamps, etc.)

24 Gramm-Rudman (Balanced Budget) Act of 1985 Called for automatic cuts from 1986–1991, until the federal deficit disappeared Called for automatic cuts from 1986–1991, until the federal deficit disappeared If there was a lack of agreement between the president and Congress on the total spending level, there would be automatic across-the board cut (a sequester) If there was a lack of agreement between the president and Congress on the total spending level, there would be automatic across-the board cut (a sequester) The president and Congress still found ways to increase spending, however The president and Congress still found ways to increase spending, however

Budget Strategy Congress voted a tax increase and the Budget Enforcement Act capped non- entitlement (discretionary) funding Congress voted a tax increase and the Budget Enforcement Act capped non- entitlement (discretionary) funding If entitlement spending increased, there had to be cuts in discretionary spending or taxes had to be raised If entitlement spending increased, there had to be cuts in discretionary spending or taxes had to be raised Expired in 2001, but may be re-instated Expired in 2001, but may be re-instated

26 Levying Taxes Most revenue was derived from tariffs until ratification of the Sixteenth Amendment (1913) Most revenue was derived from tariffs until ratification of the Sixteenth Amendment (1913) Taxes then varied with war (high) and peace (low) Taxes then varied with war (high) and peace (low) Offsetting high tax rates were various deductions or exemptions Offsetting high tax rates were various deductions or exemptions

27 Levying Taxes Tax Reform Act of 1986-instead of high rates with big deductions, low rates with smaller deductions (didn’t actually work b/c rates went right back up) Tax Reform Act of 1986-instead of high rates with big deductions, low rates with smaller deductions (didn’t actually work b/c rates went right back up) George H.W. Bush and Clinton increased tax rates, keeping deductions low George H.W. Bush and Clinton increased tax rates, keeping deductions low Balanced budget switched policy debates to tax cuts, but Social Security and Medicare policy problems remain Balanced budget switched policy debates to tax cuts, but Social Security and Medicare policy problems remain See p.501 & 503 See p.501 & 503