Government and the U.S. Economy

Chapter 12

Government’s Role in the Economy

• “Public Sector”All levels of the government.

• “Private Sector”Businesses

Government’s Role in the Economy

Are businesses and individuals better off when decisions are made through voluntary exchange in markets, or does some type of government intervention better serve the public?”

Government’s Role in the Economy

Functions of the Government Establish and enforce private property rights and

the law. Deal with external costs and benefits. Ensure market competition. Protect consumers. Stabilize the economy. Promote economic security. Provide public goods and services.

The Government’s Many Roles

•Arbiter

•Manager

•Participant

Establishment and Enforcement of Private

Property Rights

• Provides rules and regulations.

• Enforces those rules.

• Helps to insure trust and honesty.

• Helps support ideals of free enterprise system.

Deal with External Costs and Benefits

• Referred to as externalities or “spillovers”

• Government takes care of third-parties who are indirectly bearing the cost or being hurt by another’s decisions.

• Gov. organizations, like EPA, set the tables straight, and make things right.

Ensure Market Competition

• Fight monopolies and price fixing.

• Passed Antitrust LegislationSherman Antitrust Act (1980)Clayton Act (1914)Federal Trade Commission Act (1914)Celler-Kefauver Antimerger Act (1950)

Protect Consumers

• Federal Agencies that enforce laws and protect the general public.

• Develops standards and rules for producing goods and services.

Government as a Manager

• Coordination of resources is usually taken care of by “motivation” of producers at different levels.

• Government can intervene and assist by redirecting resources.

Stabilize the Economy

• Economy goes through “business cycles”

• Government’s role is to “ease” the pain of these cycles.

• Goals of the government are to: Encourage economic growth Control unemployment Keep inflation in check

Tools of the Government

• Fiscal PolicyTaxes and Government SpendingGovernmental decisions by President &

Congress

• Monetary PolicyControls money supplyFederal Reserve BoardAffects costs of money

Promote Economic Security

• Distribution of Income in U.S. is not equal. (The haves have, and have nots, have not)

• Sets up programs involving governmental transfers of money.

• Programs set up to help people fall into two categories:

Programs to increase income and the standard of living. Programs to eliminate the causes of poverty and

economic disadvantage.

Government as a Participant

• Government is a vital participant in the “Circular Flow Model”

• Has the role as both:

a producer

and a consumer.

Provides Public Goods and Services

• For some things, it just makes sense for the government to handle it, because everyone benefits.

• Where is the line between purely public or private goods and services?

• Governments are shifting away from providing some goods and services. “Privatizing”

Government Decisionsvs.

Market Decisions

• Competition vs. No Competition

• Maximizing Profits vs. Fairness

• Efficient Use of Resources vs. Limited Spending

• Consumer Use vs. Taxpayer Use

• Voting by Purchase vs. Voting and Abiding

Public and Private Interaction

• Separate components of economy

• Continuous interaction between government and business

• Subsidies (financial aid)

• Tax Incentives

Governmental Spending

• Fiscal - means financial. Deals with budgeting or accounting purposes, we often refer to a “fiscal” year, or “fiscal budget”.

• Direct Benefit payments to individual Social security, medicare, income security, health & veterans’ benefits More than half of budget is spent on this area, continues to grow.

• National Defense Second largest category; 16 cents of each budget dollar

• Net Interest Third largest category; national debt; transfer payments to individuals &

businesses that have lent money to government

• Grants to States and Localities Health & income security

How the Government Gets Money

• TaxesFederal & State Income Taxes (FICA)Property TaxesSales TaxesCorporate TaxesEstate & Gift TaxesCustoms duties (tax)

State & Local Finances

• Budgets are getting bigger

• Get money from tax receipts

• Get money from Federal Government in the form of government aid. (Grants)

The Role of Government in the Circular Flow

• Role with Households Provides government goods and services Pays wages, salaries, and transfers Receives tax dollars Receives labor and other resources

• Role with Businesses Pays out government payments Provides government goods & services Receives taxes Receives goods and services

Taxes

• Why? To pay for the cost of government. To protect certain industries (tariffs on

foreign goods) Acts as a discouragement (cigarettes); sin

tax Anti-tax (tax incentives)

Tax Incidence

• Refers to the final impact of a tax; who will really have to pay for it.

Who Should Pay Taxes?

• BENEFITS-RECEIVED PRINCIPLETax those that receive the benefits of

the tax. (Toll Roads and Bridges)

• ABILITY-TO-PAY PRINCIPLETax those people that have the greater

ability to pay the taxes. (Those with higher incomes)

Types of Taxes

• PROPORTIONAL TAXTax that takes the same percentage of

all incomes.

• PROGRESSIVE TAXTax that takes a larger percentage of a

higher income and a smaller percentage of a lower income.

Types of Taxes

• REGRESSIVE TAXTax that takes a higher percentage of

taxes from low-income persons than from high-income persons. (Sales Tax)

Where do tax dollars come from?

• Four Main Types of Federal Taxes

Personal IncomeSocial Insurance (Social Security)Corporate IncomeExcise

Government Budgets

• Balanced Budget

• Deficit (Debt)

• Surplus

National Debt

• The cumulative sum of all borrowing that is necessary to finance annual deficits.

• Includes money owed to US citizens and businesses, foreign lenders, and money to itself.

Justification for Deficits

• Not as large as it seems. Depends on how you look at it.

• When economy is poor, the deficit might increase the total spending of the nation.

Criticism of the National Debt

• Annual interest payments on the national debt have been a large growing portion of the federal budget.

• Large deficits might lead to higher interest rates.

• Deficits and private investment might go decrease.

• Inflation might result from printing more money.

• Government should live within its means.

Proposals to Reduce the Deficit

• Maximum amounts that could be afforded to discretionary spending.

• New mandatory programs must be offset by an increase in taxes or a reduction in other mandatory spending.

• Tax Cuts