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Economic Policy
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Economics = the ways we have devised to share scarce
resources
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What gets produced?
How does it get produced?
Who produces it?
Who gets the goods?
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We are a free market system
Private individuals make these decisions
 Generally based on incentives
 The Government steps in when there are problems and tries to ensure that
the economy is healthy
 The government tries to use incentives and usually there are some
unintended consequences…
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The government influences the economy in many
ways
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One is through taxation
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The government can use tax dollars (revenue) to create
programs to provide jobs…
The government can decrease taxes during a recession to
encourage people to spend more and stimulate the economy
The government also needs to tax Americans in order to
have money to function
Revenue – income that the government collects
 Taxes – source of government revenue
 Fiscal year- a 12 month period used for
calculating financial reports
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Helps you formulate your budget for next year
Gov’t fiscal year begins on October 1 and ends on
September 30
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Individual income tax – taxes we pay from our salary , makes up about
50% of government revenue
Corporate income tax – based on a corporations net income, makes up
about 10% of government revenue
Social Insurance Tax- money collected from both employers and
employees to run Social Security and Medicare, makes up about 32% of
government revenue
Excise Tax – taxes added to the sale price of certain goods ( alcohol &
tobacco), makes up about 3% of government revenue
Custom Duties – tariffs or import duties, taxes levied on goods brought
into the country, make up about 1% of government revenue
Estate Tax- tax placed on a deceased person’s assets when they are
transferred to another person
Gift Tax- tax placed on certain gifts given to individuals
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Estate and gift taxes make up about 1.5% of government revenue
1. Individual Income Tax
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Passage of 16th Amendment brought the advent of the
income tax in America ( 1913)
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Largest source of revenue for fed. Gov’t
Progressive tax – larger percent from high income earner
than low income earner
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In 1913 the tax rate was 1 % on taxable net income above $3,000 ($4,000
for married couples). It rose to a rate of 7 % on incomes above $500,000.
During World War I the top rate rose to 77 %; following the war, the top
rate was scaled down (to a low of 25 %).
During the Great Depression and World War II, the top income tax rate
rose again, reaching 91% during the war; this top rate remained in effect
until 1964.
In 1964 the top rate was decreased to 70% (1964 Revenue Act), and then
to 50% in 1981 (Economic Recovery Tax Act).
The Tax Reform Act of 1986 reduced the top rate to 28%, at the same
time raising the bottom rate from 11% to 15% (in fact 15% and 28%
became the only two tax brackets).
During the 1990s the top rate rose again, standing at 39.6% by the end of
the decade.
The top rate was cut to 35% and the bottom rate was cut to 10% by the
Economic Growth and Tax Relief Reconciliation Act of 2001.
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Each person is allowed exemptions and deductions
 Exemptions – non-taxable income
 Dependents: someone who lives with you and doesn’t provide
an income
 Married: $12,000
 Single: $7,000
 Retirement account
 Tax-Free education savings plans
 Deductions – amounts the gov’t allows you to subtract from
your taxable income
 Charitable donations
 Medical expenses
 Education
 Interest on you mortgage
Generally your employer deducts a certain
amount of your salary each pay period and sends
it to the IRS ( Internal Revenue Service).
 The IRS is part of the Treasury Department.
 Overpayments are refunded during the next
calendar year, underpayments will be paid by
YOU the next calendar year.
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On or before April 15th , all US residents who earned
taxable income the preceding year must file their tax
returns with the IRS
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2011 Tax day is April 18th (April 15th is a holiday in Washington DC)
You should receive tax information from your employer, bank,
investment firm, or any other source of income by the middle of
January.
Tax returns list all sources of a person’s income, any
exemptions and deductions, and the amount of $ he/she
owes to or is owed by the IRS.
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Based on all income earned above the cost of maintaining
the business
Corporations are allowed many different types of
deductions, making it the most complicated federal tax to
figure out
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Deductions are considered tax breaks given to corporations to
help achieve a national goal
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A corporation may be able to deduct the cost of expanding and
modernizing if it will help the national economy.
The most recent addition to corporate deductions are ‘green’
deductions
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Collected from employers and employees to pay
for the running of Medicare and Social Security
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Funded through taxes collected under the Federal
Insurance Contributions Act ( FICA)
FICA taxes are withheld from workers’ pay, the employer
matches the amount and sends the full payment to the
federal government
American Corporation
1111 Apple Lane
Anywhere, NJ 08000
Gross income: 5,256.00
3,648.77
Federal income tax: 953.22
Social Security tax: 325.87
Medicare: 76.21
NJ State Tax: 203.31
Unemployment: 22.34
Disability: 26.28
Check #: 999
Date: 1/30/08
Net income:
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Taxes levied on the sale, manufacture, or
consumption of certain goods
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Tobacco , alcohol, gasoline, telephone service, …
This is called a flat tax, all people have to pay the same
tax on these goods
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Seen as more of a burden for the poor than the rich
Both taxes are progressive, as the value of the
Estate or gift increases so does the amount of
tax to be paid
 Estate Tax – a tax placed on a deceased person’s
assets when they are transferred to someone
else
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Great Aunt Millie dies and you take over her estate, you
have to pay taxes on it if the estate is worth more than
$12,000
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Gift Tax – a tax placed on the transfer of certain
gifts of value to individuals
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Taxes are only levied on gifts over $12,000
Fred Flood has 2 children and 4 grandchildren. He can
give each child and grandchild $12,000 per year without
incurring a gift tax liability. If he's married, his spouse
can make the same gifts, again without a gift tax
liability.
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Also know as tariffs or import taxes
Taxes levied on goods brought into the United States from
abroad
Used to create revenue and protect American business,
agriculture, and industry from foreign competition
 Constitution gives Congress the power to levy taxes, Congress
has authorized the president to raise and lower these duties by
certain percentages
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These decisions are based on the recommendation of the U.S.
International Trade Commission (ITC)
If the president doesn’t follow ITC recommendations Congress can
override the president with a 2/3 vote.
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Main source is composed of earnings by Federal Reserve
banks
Fees the government charge banks to borrow money
 Know as the Federal Reserve Interest Rate
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Fees and fines collected by other agencies also provide
revenue
Passport fees
 Copyright fees
 Fines from federal courts
 Sales or lease of federal lands
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Democrats:
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generally favor higher taxes for the wealthy – seeking to
fund government programs
Republicans:
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generally favor lower taxes for all
1970’s – growing opposition to the way the
government spends our tax dollars
 Many want to do away with federal taxes!
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Supply side economics – taxes should be lowered to
stimulate the economy, if you have more net income
you will spend more $ on goods and thus stimulate
production
Economy was facing stagflation
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Inflation as well as low growth in the industrial sector
http://www.billshrink.com/blog/5626/governme
nt-wastes/
 http://coburn.senate.gov/public/index.cfm?Fus
eAction=Files.View&FileStore_id=9badb127e02d-49b0-946d-a2bd8cb50eae
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Proponents:
Inequality in society works to
keep wealth unevenly
distributed in our society
 Government should redistribute
the wealth to help those less
fortunate
 This is one way to help end
classism in our society
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Opponents:
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Uneven distribution of wealth
reflects education, effort, and
contributions to society
If we redistribute the wealth it
will cause the general standard
of living of many to go down
unfairly
Discourages people from
working hard and making
contributions to society
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There is more to economic policy than just
raising and spending money this section focuses
on the following:
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Organization of U.S. economy
2 main goals of economic policy
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1.Stabilize the economy
Full employment
 Low inflation
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2.Promote economic growth
Tax cuts
 Increased government spending
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U.S. has a free enterprise economy
One in which business can be conducted freely, with little
government intervention
 Depends on a market in which goods and services are
exchanged openly and freely
 Goods are produced according to demand
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If the consumer demand is higher for jeans than ball gowns, more
jeans will be produced
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Private ownership of business and free markets
provide the best opportunity for economic
growth
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Business people are motivated to make more money so
they will come up with new things to produce and better
ways to produce them
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The requests for copyrights and patents grow each year
The right to own property and enter into
contracts
 The right to make individual choices
 The right to engage in economic competition
 The right to make decisions based on self
interest
 The right to participate in the economy with
limited government involvement
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Basic principal: How involved should the government be in
the free market?
How should the government handle unemployment?
 How should the government deal with recessions?
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Recession: economic downturns that occur every 5 to 10 years. At
least 6 months of slow economic growth.
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CAUSES:
 shift in economy – from industrial complex to multinational complex
 Overproduction – prices fall, business losses $, people lose jobs
 Credit crunch- loans are less available to people due to inflation
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http://www.getrichslowly.org/blog/2009/02/25/
the-credit-crisis-visualized/
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Democrats – traditionally favor greater
government involvement in the economy
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Johnson- Great Society, War on Poverty
FDR – government regulation of business practices, New
Deal and programs to provide direct aid to individuals
Gain their support from those in lower income brackets
who are more effected by recessions
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Republicans generally follow the policy of laissez
faire when it comes to government intervention
in the economy
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Harding and Coolidge allowed businesses to regulate
themselves
Generally gain support from higher income voters who
gain from self regulation and have a ‘cushion’ against
mild economic downturns
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The 2 main goals of stabilization policy
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Full employment – people need an income to survive,
during recessions employment levels drop
Low inflation – inflation is the general rise in the cost of
things, when inflation rises too high too fast it causes
interest rates to rise which decreases the likelihood
people will borrow $ and invest in the economy ( starting
a new plant, buying a new home)
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Fiscal policy: a set of government spending, taxing,
borrowing policies used to achieve desired levels of
economic performance. Fiscal policy is determined by the
legislative and executive branches
Monetary Policy: a set of procedures designed to regulate
the economy by controlling the amount of $ in circulation
as well as the level of interest rates. Monetary policy is
determined by the Federal Reserve System
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Fed gov’t uses the budget to develop fiscal
policy through taxing and spending plans
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Budget formulated by looking at the last fiscal year
If the government increases spending or decreases
taxes they can increase the overall demand for goods
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This is used to put more money into a slow economy to
stimulate growth
The gov’t may decrease spending if a rapidly
growing economy is producing unwanted
inflation.
 Decrease taxes if a slow economy is causing the
unemployment rate to rise
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More disposable income = spend more $ on
goods=businesses can produce more goods= new hiring
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When inflation is high the gov’t may raise taxes
to decrease consumer spending and cut down
on a corporations profits, this slows down
business activity and thus helps to lower
inflation
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The objective of monetary policy is to influence
the country's economic performance to promote
stable prices, maximum sustainable
employment, and steady economic growth.
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Controlled by the Federal Reserve Board
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Central banking system of the US
Divided into 12 district banks that perform regulatory
functions for banks in their districts
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manages our nation's supply of money and credit and operates at
the center of the nation's financial system;
keeps the wheels of business rolling with currency, coin, and
payments services, such as electronic funds transfer and checkclearing;
serves as the banker for the federal government by providing
financial services for the U.S. Department of the Treasury;
supervises and regulates a large share of the nation's banking and
financial system; and
administers banking and finance-related consumer protection
laws
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The nation needs a money manager because money does not
manage itself. Money and credit are the lifeblood of the
economy; they facilitate commerce, job creation, and business
growth. As our nation's money manager, the Fed implements
monetary policy to manage the flow of money and credit in the
economy. If money and credit expand too rapidly, businesses
cannot produce enough goods and services to keep up with
increased spending. Prices may rise, causing inflation. If the flow
of money and credit contracts too greatly, spending and business
activity may dwindle, workers may lose their jobs, and a
recession may result. As our nation's money manager, the Fed
conducts monetary policy to attempt to balance these two
extremes to keep prices steady, workers employed, and factories
productive
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The Fed regularly reports to Congress about its
activities and plans for monetary policy.
Although Congress has the power to change the
laws governing the Fed and its operations, the
central bank's day-to-day policy and operational
decisions do not require Congressional or
Presidential approval.
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The Fed's monetary policy actions affect prices,
employment, and economic growth by influencing the
availability and cost of money and credit in the economy.
This in turn influences consumers' and businesses'
willingness to spend money on goods and services.
The Fed uses three monetary policy tools to influence the
availability and cost of money and credit: open market
operations, the discount rate, and reserve requirements.
Tool the fed uses to implement monetary policy
 Rules for banks: determines the minimum
amount of $ that a bank must keep on hand at
all times, if the amount in raised the bank can’t
make as many loans and the money supply out in
the market is decreased
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If the amount are lowered the opposite effect will occur
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The interest rate that the Fed charges to banks
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A bank may need to borrow $ from the Fed so it can loan
that $ out
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If the Fed lowers the discount rate banks are more inclined
to borrow from the Fed, they will be able to lend out more $
and cause more $ to be out in the market
If the Fed raises discount rates banks are less likely to
borrow $, they will be less likely to lend out $ and there will
be less money out in the market
Real life example: current situation
U.S. auto sales, which supply billions of dollars
annually to the economy
 Stock value increases, which may cause people
to spend more, thus pushing prices up
 Supplier performance, which might push up
prices when suppliers fail to keep up with the
demands of retailers’
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Most common Fed influence on the economy
The government issues/sells bonds in order to finance
government operations
U.S. Government Bonds
The bonds issued by Uncle Sam are called Treasuries. They're
grouped in three categories.
 U.S. Treasury bills -- maturities from 90 days to one year
 U.S. Treasury notes -- maturities from two to 10 years
 U.S. Treasury bonds -- maturities from 10 to 30 years
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Monetary Policy – control
of $ in circulation and
interest rates
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Faster – enacted by an
independent body,
effective immediately
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Fiscal Policy – taxing,
spending, and borrowing
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Slower, tied to annual
budgets- has to come from
Congress of the Pres.
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Econ policy set forth by John Maynard Keynes in
the 1930’s
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The government should actively be involved in economic
stimulation
It is ok for the government to spend more than it makes
– deficit spending
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Monetarism: The economy should be left alone,
it will work out economic problems on it’s own
and create a situation of low inflation and full
employment.