Download Chapter 18: Economic Policy

Chapter 18:
Economic Policy
Theories of Economic Policy
• Economic theories explain how market
economies work
• Laissez-Faire Economics
– Laissez-faire: absence of government control over the
economy
– Adam Smith: “the invisible hand”
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Theories of Economic Policy
• Keynesian Economics
– Laissez-faire policies cannot do anything about economic
depression or raging inflation
• Economic depression: a period of high unemployment and
business failures; a severe, long-lasting downturn in the
business cycle
• Inflation: an economic condition characterized by price
increases linked to a decrease in the value of the currency
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Theories of Economic Policy
• Keynesian Economics
– Capitalist economies may suffer through many business
cycles
• Business cycles: expansion and contractions of business
activity, the first accompanied by inflation and the second by
unemployment
• U.S. has experienced more than 15 business cycles
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Theories of Economic Policy
• Keynesian Economics
– Keynes argued that business cycle fluctuations result from
imbalances between aggregate demand and productive
capacity
• Aggregate demand: the money available to be spent on
goods and services
• Productive capacity: the total value of goods and services
produced when the economy works at full capacity
• Gross domestic product (GDP): the value of goods and
services actually produced
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Theories of Economic Policy
• Keynesian Economics
– Keynesian theory: an economic theory that states that the
government can stabilize the economy – that is, can smooth
business cycles – by controlling the level of aggregate demand,
and that the level of aggregate demand can be controlled by
means of fiscal and monetary policies
• Fiscal policies: economic policies that involve government taxing
and spending
• Monetary policies: economic policies that involve control of, and
changes in, the money supply
– Most capitalist countries have adopted Keynesianism in some
form
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Theories of Economic Policy
• Monetary Policy
– The political utility of Keynesian fiscal policies is limited
– Monetarists: those who argue that government can
effectively control the performance of an economy only by
controlling the supply of money
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Theories of Economic Policy
• Monetary Policy
– Federal Reserve System (“the Fed”): the system of banks
that acts as the central bank of the United States and
controls major monetary policy
• Controls the money supply in 3 ways
– Selling and buying U.S. government securities
– Changing the target for the federal funds rate
– Changing the reserve requirement for banks
• Has historically acted to combat inflation rather than
stimulate economic growth
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Theories of Economic Policy
• Supply-Side Economics
– Supply-side economics: economic policies aimed at
increasing the supply of goods (as opposed to increasing
demand), consisting mainly of tax cuts for possible
investors and less regulation of business
– “Reaganomics”
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Public Policy and the Budget
• Since 1921, the president has been responsible
for drafting and submitting the budget to
Congress for approval
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Public Policy and the Budget
• The Nature of the Budget
– Budget: the annual financial plan that the president is
required to submit to Congress at the start of each year
– Budget outlays: the amount that government agencies
are expected to spend in the fiscal year
– Receipts: for a government, the amount expected or
obtained in taxes and other revenue
– The difference between receipts and outlays is the deficit
– Public debt: the accumulated sum of past government
borrowing owed to lenders outside the government
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Public Policy and the Budget
• Preparing the President’s Budget
– The preparation of the budget is supervised by the Office
of Management and Budget (OMB)
– President’s budget is the starting point for Congress
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Public Policy and the Budget
• Passing the Congressional Budget
– The Traditional Procedure: The Committee Structure
• 3 types of committees involved in budgeting
• Does not allow Congress as a whole sufficient control over
the budget process
– Reforms of the 1970s: The Budget Committee Structure
– Lessons of the 1980s: Gramm-Rudman
– Reforms of the 1990s: Balanced Budget
– Backsliding in the 2000s: Deficits Return
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Tax Policies
• Designed to provide a continuous flow of
revenue without requiring new annual legislation
– May be used to accomplish many objectives
– Major revenue source: individual income taxes (45%)
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Tax Policies
• Tax Reform
– The Tax Reform Act of 1986
• One of the most sweeping changes in history
• Eliminated many brackets; approached a flat tax
• Flat tax violates principle of progressive taxation: a system
of taxation whereby the rich pay proportionately higher taxes
than the poor
• Number of tax brackets increased by George H.W. Bush and
Bill Clinton
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Tax Policies
• Tax Reform
– Changes to law in 2001 and 2003
• Increased number of brackets, but changed trigger points
• Reduced revenue, resulted in deficits
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Tax Policies
• Comparing Tax Burdens
– The tax burden has not increased since the 1970s for
middle income families in the United States
– American tax burden is still low compared with that of
other major industrialized democratic nations
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Spending Policies
• FY 2007 budget accounted for $2.8 billion in
proposed outlays
• Incremental Budgeting…
– Incremental budgeting: a method of budget making that
involves adding new funds (an increment) onto the amount
previously budgeted (in last year’s budget)
– Earmark: government funds appropriated to be spent for a
specific project
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Federal Spending in 2007, by Function
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Spending Policies
• … and Uncontrollable Spending
– Uncontrollable outlay: a payment that government must
make by law
– Almost 2/3 of FY 2007 outlays were uncontrollable or
relatively uncontrollable
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National Government Outlays Over Time
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Government Outlays and
Receipts as a Percentage of GDP
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Taxing, Spending, and Economic Equality
• Economic equality requires economic freedom
to be compromised through redistribution of
wealth
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Taxing, Spending, and Economic Equality
• Government Effects on Economic Equality
– Transfer payments: a payment by government to an
individual, mainly through social security or unemployment
insurance
– Progressivity of national income tax has varied over time
– Combination of national, state, and local taxes may violate
progressivity
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Taxing, Spending, and Economic Equality
• Effects of Taxing and Spending Policies Over
Time
– Between 1966 and 2004, gap in income between rich and
poor grew
– U.S. has most unequal distribution of
comparative study of 18 developed countries
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income
in
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Taxing, Spending, and Economic Equality
• Democracy and Equality
– Distribution of wealth is highly unequal
• Wealthiest 1% of families control 33% of household wealth
• Distribution between ethnic groups also highly unequal
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Taxing, Spending, and Economic Equality
• Democracy and Equality
– Why don’t “the people” share in the nation’s wealth?
• Little support for increasing income tax
• More support for regressive taxation: national sales tax,
lottery
– Most Americans don’t understand the inequalities of the
national tax system
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Distribution of Family Income over Time
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