chapter 17 economicpolicy. learning outcomes 17.1 compare and contrast three theories of market...

Chapter 17Chapter 17

ECONOMIC ECONOMIC POLICYPOLICY

Learning Outcomes17.1 Compare and contrast three theories of market economics: laissez-faire, Keynesian, and supply-side.

17.2 Describe the process by which the national budget is prepared and passed into law and the reforms undertaken by Congress to balance the budget.

17.3 Identify the objectives of tax policies and explain why tax reform is difficult.

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Learning Outcomes17.4 Identify the major areas of government outlays and explain the role of incremental budgeting and uncontrollable spending on the growth of government spending.

17.5 Identify the origins of the income tax, trace the influence of government spending and taxing policies on inequality, and examine these policies from the majoritarian and pluralist perspectives.

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Theories of Economic Policy Laissez-Faire Economics

Absence of government control Strict advocates maintain government interference with

business obstructs workings of the free market Mainstream economists today favor market principles but

recognize that “government can sometimes improve market outcomes”

Efficient market hypothesis has held that financial markets are informally efficient

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Theories of Economic Policy Keynesian Theory

John Maynard Keynes Business cycles stem from imbalances between

aggregate demand and productive capacity Productive capacity – gross domestic product

Government could stabilize economy by controlling level of aggregate demand

Aggregate demand can be adjusted through fiscal and monetary policies Low demand: government spend more money or cut taxes Demand too great: government spend less or raise taxes

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Theories of Economic Policy Keynesian Theory (cont.)

Capitalist countries have widely adopted Keynesian theory in some form

Employment Act in 1946, reflects Keynesian theory Established government responsibility for economy Tremendous effect on government economic policy Council of Economic Advisors (CEA)

Keynes-Hayek: debate in 2012 election Obama auto industry bailout (Keynes) Romney “Let Detroit Go Bankrupt” (Hayek)

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Dueling Economists on YouTube

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Theories of Economic Policy Monetary Policy

Monetarists, such as Nobel Laureate Milton Friedman, argue that government can control the economy’s performance simply by controlling the nation’s money supply Monetary policies are under control of Federal Reserve

System in U.S. Three goals: Controlling inflation Maintaining maximum employment Insuring moderate interest rates

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Theories of Economic Policy Monetary Policy (cont.)

2010 Dodd-Frank financial reform bill granted even greater powers to the Fed to regulate large complex financial firms

Ways the Fed controls money supply Sells securities, takes money out of circulation, raising

interest rate Buys securities, process in reverse, lowers interest rate Sets federal funds rate – rate banks charge one

another for overnight loans Less frequently, may change its discount rate Can change its reserve requirement

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Theories of Economic Policy Monetary Policy (cont.)

Formally, president responsible for state of the economy and voters hold him accountable President neither determines interest rates (Fed does)

nor controls spending (Congress does) Fed’s activities are essential parts of government’s

overall economic policy but lie outside president’s control and in hands of Fed chair Fed Chair – Critical player in economic affairs

Ben Bernanke – Stretched Fed’s authority during financial crisis of 2008

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Theories of Economic Policy Supply-Side Economics

Stimulate investment through tax cuts and less government regulation of business

Reaganomics Economic Recover Tax Act of 1981

Tax cuts Cuts in spending for social programs Deregulation Increases in defense spending

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Theories of Economic Policy Supply-Side Economics (cont.)

How Well Did Reaganomics Work? Worked as expected, except deficit

Inflation dropped:13% in 1981 to 3% by 1983 Due more to Fed chair Paul Volcker’s actions

Deregulated business Unemployment increased to 9.6% Didn’t reduce budget deficit

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Public Policy and the Budget Congressional budgeting

Congress in charge of budget until 1921

Today, President prepares budget, Congress approves it Budget and Accounting Act of 1921

Established Bureau of the Budget (now Office of Management and Budget) to prepare president’s budget to be submitted to Congress each January

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Public Policy and the Budget The Nature of the Budget

Budget of the United States Government – annual plan Applies to next fiscal year – October 1 to September 30 Defines budget authority and outlays Receipts – expected tax and revenues Deficit – difference between receipts and outlays National debt – sum of all unpaid government deficits

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Public Policy and the Budget Preparing the President’s Budget

The Office of Management and Budget (OMB) oversees process OMB initiates process in spring, agencies prepare

budgets in summer and submit to OMB in fall, analysts review requests, negotiations until budget goes to printer

Proposed budget submitted to Congress

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Public Policy and the Budget Passing the Congressional Budget

The Traditional Procedure Tax committees

Ways and Means in the House Finance in the Senate

Authorization committees Approximately 20 in House; Senate 15

Appropriations committees: House and Senate More powerful than authorization committees

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Public Policy and the Budget Passing the Congressional Budget (cont’d)

Two serious problems in budgeting process Spending process is complex No one is responsible for budget as a whole

Budget committees supervise comprehensive review process aided by Congressional Budget Office (CBO)

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Public Policy and the Budget Passing the Congressional Budget (cont’d)

Congress tried twice to pass Budget Enforcement Act (BEA) of 1990 Defined spending

Mandatory spending Discretionary spending

Previous laws paved way for Clinton’s Balanced Budget Act of 1997 (BBA) Led to balanced budget and produced a surplus

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Public Policy and the Budget Passing the Congressional Budget (cont’d)

Congress allowed caps on discretionary spending to expire at end of 2002

Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Control Act in 1985 Law utter failure, deficit targets eliminated in 1990

Balanced budget amendment (BBA) introduced again in 2011 but failed

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Tax Policies Reform

Reform proposals influenced by interest groups Pre-1987 – 14 income brackets

President Reagan reduced to two Flat tax violates principle of progressive taxation

Progressive taxation allows government to redistribute wealth and promote economic equality

Presidents G.H.W. Bush and Clinton added two more brackets, moved to more progressive tax structure

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Tax Policies Reform (cont.)

George W. Bush pushed Congress to pass tax cuts Reduced revenues increased deficits Economic downturn, homeland defense, and military

expenses compounded problem Bush’s last budget – over a trillion dollars deficit

Deficit continued to grow under Obama 2012, Obama campaigned to restore 39.6 tax bracket

for highest tax bracket

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Tax Policies Comparing Tax Burdens

Tax burden on U.S. citizens has decreased since 1950s

Tax burden not large compared to other democratic nations Almost every democratic nation taxes more heavily than

the U.S. does

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Spending Policies Incremental Budgeting…

Agencies submit budgets based on previous year Congress rarely looks at base budget items Few agencies ever cut back, spending continually goes

up Earmarks greatly increased until early 1990s

Congress declared moratorium on earmarks after 2010 election Some members repackaging them as “special funds”

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Spending Policies …and Uncontrollable Spending

Earmarks are discretionary outlays Most government spending is mandatory outlays and

uncontrollable without change in law authorizing program

Politics argue against large-scale reductions

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Taxing, Spending, and Economic Equality

Government Effects on Economic Equality Do government spending policies have measurable

effect on income inequality? Government payments to individuals: transfer

payments Don’t always go to poor

Farm program: Wealthiest farmers often receive largest subsidies

Have definite effect on reducing income inequality National tax policies at all levels have historically

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Taxing, Spending, and Economic Equality

Effects of Taxing and Spending Policies over Time Poorer citizens pay higher percentage of income in

taxes than wealthier citizens In capitalist system, some degree of inequality is

inevitable

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FIGURE 17.5 Distribution of Family Income over Time

Taxing, Spending, and Economic Equality

Democracy and Equality U.S. prizes political equality, but economic equality not

as strong Wealthiest 1% control 35% of nations household wealth Distribution among ethnic groups alarming

Typical white family’s annual income 1.5 times of blacks and Hispanics

One theory - Pluralist interest group activity distorts government’s efforts to promote equality

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Taxing, Spending, and Economic Equality

Democracy and Equality String of Gallup polls from 1985 to 2008:

Clear majority said distribution of wealth not fair and favor some redistribution – but not through heavy taxes on rich

Favor national sales tax or weekly lottery Sales tax, flat tax = regressive effect, promoting inequality Lottery also contributes to wealth inequality

Poor more willing to chance income than rich

Majoritarians argue most Americans don’t understand inequities of national tax system

Economic policy determined through pluralist politics

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