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Economic Policy
The politics of deficit spending
The general landscape
 Deficit: government spending over and above the amount
taken in by taxes
 National debt: combined amount of all deficits
 Interest on the debt: typically the third highest item in the
national budget
 Gross domestic product (GDP)- proportion in relation to
debt about the same as 1964
Strategy: get rid of the annual deficit to make
progress on the overall debt
 By raising taxes (political liberals)
 By cutting spending (political conservatives)
Fiscal Policy
Managing the economy by the use of
tax and spending laws.
 Where the Money Comes From
 Federal Income Taxes
 Social Insurance Taxes
 Borrowing
 Other taxes
 Where the Money Goes
 Entitlement programs
 National defense
 National debt
Where does the Money come from?
Where does the Money go?
Monetary Policy
Managing the economy by altering the
supply of money and interest rates
 Monetary policy is the government’s
control of the money supply
 Too much money in the system leads
to inflation (devaluation of dollar)
 Too little money in circulation leads
to deflation
The Politics of Economic Prosperity
Health of American economy creates majoritarian politics
 Voters influenced by their immediate economic situations
 Voters worry about the nation as a whole as well as their own
situations
Voting behavior and economic conditions correlated at the
national level but not at the individual level
 People understand what government can and cannot be held
accountable for (ex.You get fired b/c govt cut funding vs. you’re
always late)
 People see economic conditions as affecting them indirectly, even
when they are doing well (see others struggling, worry it could be
them soon)
What politicians try to do
 Elected officials tempted to take short-term view of the economy
Government uses money to influence elections (Congress passes
favorable laws in election year), but government will not always
do whatever is necessary. Why?:
 Government does not know how to produce desirable
outcomes
 Attempting to cure one economic problem exacerbates
another
Ideology plays a large role in determining policy
 Democrats tend to want to reduce unemployment
 Republicans tend to want to reduce inflation
Everybody wants both, but have to choose to focus on one
The Politics of Taxing and Spending
Inconsistency in what people want
from majoritarian politics
 No tax increases
 No government deficit
 Continued/increased government
spending
Difficult to make meaningful tax cuts
 Politicians get reelected by
spending money
 Strategy: raise taxes on “other
people”
Economic Theories & Political Needs
More Liberal (more programs)
 Keynesianism – government should create right level of demand
Too little = production declines

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Govt should spend more to stimulate econ
Too much = prices rise, shortages occur

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Govt should tax more or cut spending
Planning – free market too undependable to ensure economic
efficiency; therefore government should control it

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Government should have ability to set prices and wages to create healthy
and stable economy
Economic Theories & Political Needs
More Conservative (less govt.)
 Supply-side tax cuts – need for less government interference and
lower taxes (opposite of planning advocates)

Cut taxes people will save and invest greater econ productivity
will increase tax revenue (and people won’t feel the need to “cheat” on
their taxes!)
Monetarism – inflation occurs when there is too much money chasing
too few goods;
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Govt reacts by cutting amount of $ in circulation -triggers recession
Monetarists advocate increase in money supply about equal to the rate
of economic growth (slow and steady wins the race)
Economic Theories & Political Needs
“Reaganomics”: Combination of monetarism, supply-side tax
cuts, and domestic budget cutting

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Slowed (but didn’t decrease) govt spending on most programs
(but raised military $$)
Cut income taxes
= big deficits!! But the economy was stimulated!
The Machinery of Economic Policy Making
Fragmented policymaking: not under president’s full control
3 people of special importance (The Troika):
 Chairman of Council of Economic Advisers
-Forecast trends, analyze issues, submit congressional report

Director of Office of Management and Budget
-Analyzes and estimates what departments will spend

Secretary of Treasury
-Estimates US revenue from taxes
-Usually closely tied to business/finance world
The Machinery of Economic Policy Making

The Fed (Federal Reserve Board)
 7 members, Pres appointed-Senate confirmed, 14yr terms
 Regulates the supply of money and interest rates
=monetary policy
 Independent of Pres and Congress (though sometimes
questionable)

Congress
 Most important! Creates the nation’s tax and spending laws
= fiscal policy
The Budget: Overview
Document that announces
 How much the government will collect in taxes
 How much the government will spend in revenues
 How expenditures will be allocated among various programs
 Over the course of the fiscal year (October 1 to September 30)
Spending decisions made with little regard to how much money is
actually available
Congressional Budget Act of 1974: Procedures
1. President submits budget
2. House and Senate budget committees analyze budget
3. Budget resolution in May proposes budget ceilings
4. Members informed whether or not spending proposals conform
to budget resolutions
5. Committees approve appropriations bills, Congress passes them,
and send them to the president for signature
6. Hard to make big changes in government spending b/c much is
mandatory (entitlements)
7. Big loophole: Congress not required to tighten government’s
financial belt (don’t have to follow president’s proposal)
Levying Taxes
Tax policy reflects blend of majoritarian and client politics
 “What is a ‘fair’ tax law?” (majoritarian)
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Tax burden is kept low; Americans pay less than citizens in most other
countries
Requires everyone to pay something; Americans cheat less than others
“How much is in it for me?” (client)
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Requires the better-off to pay more (Progressive taxes)
Progressiveness is a matter of dispute: hard to calculate
Many loopholes: example of client politics
Client politics (special interest) make tax reforms difficult
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Tax Reform Act passed (1986)- closed many loopholes
Levying Taxes
The rise of the income tax
 Most revenue derived from tariffs until 1913 and
ratification of Sixteenth Amendment (allowed income
tax)
 Taxes then varied with war (high), peace (low)
 High rates offset by many loopholes; compromise
 Constituencies organized around loopholes
Tax bills before 1986 dealt more with deductions
than with tax rates
Tax Reform Act of 1986: low rates with smaller
deductions
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Individuals benefited, Businesses suffered