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Chapter 13
Domestic and Economic Policy
LEARNING OBJECTIVES
After students have read and studied this chapter they should be able to:
 Describe the policy-making process:
o Agenda building.
o Policy formulation.
o Policy adoption.
o Policy implementation.
o Policy evaluation.
 Explain how the government determines who is in a state of poverty.
 Describe briefly major government programs to reduce poverty, including TANF,
Supplemental Security Income, food stamps, and the earned income tax credit (EITC).
 Describe the Welfare Reform Act.
 Describe trends in crime rates over the last few decades, including changes in the rate of
violent crime, theft, and murder.
 Give one or more reasons crime has decreased in the last ten years (at least mention the high
rate of incarceration).
 Explain some major provisions of the Clean Air Act of 1990 and the Clean Water Act of 1972.
 Explain the essential tools of fiscal policy, namely increasing the budget deficit during a
recession and reducing it during a boom.
 Describe how the Federal Reserve System implements monetary policy (increasing or
decreasing the rate of growth of the money supply).
 Explain why fiscal policy may be more effective against recessions, and monetary policy
against inflation.
 Identify some of the important events in the history of economic policy since World War II,
including Kennedy’s use of Keynesianism, the triggering of inflation under Johnson, Volker’s
suppression of inflation, Bill Clinton’s tax increase, and George W. Bush’s return to budget
deficits.
 Understand the concept of a marginal tax rate.
 Define progressive and regressive taxes and identify which taxes fall into each category.
 Understand the pay-as-you-go character of Social Security.
 Describe some of the proposals that have been advanced to guarantee the survival of the
Social Security system in the future.
CHAPTER OUTLINE
I.
The Policy-Making Process
The first step in the policy-making process is identifying a problem. Numerous problems
exist, but their solutions are impossible until they are identified by policymakers. Typically
this occurs through public debate. Policymakers also rely on their constituents, interest
groups, and the media to bring policy problems to their attention. The identification of a
problem, the reaction to the problem and the solution all form the policy process. There are
five key steps in this process.
A. Agenda Building. This is the effort of identifying a problem and getting it on the
agenda. This may come about through crisis, or through the lobbying efforts of interest
groups or others concerned about the problem.
B. Policy Formulation. This consists of the debate that occurs among government officials
and the public in the media, in Congress, and through campaigns.
C. Policy Adoption. This is the selection of a strategy for addressing the problem from
among the solutions discussed.
D. Policy Implementation. This is the administration of the policy adopted by
bureaucrats, the courts and others.
E. Policy Evaluation. Groups evaluate the policy to determine if it has had the desired
impact. The feedback also evaluates unintended consequences of the policy adoption.
The feedback is considered part of the agenda building and formulation process, so
that policy can be “fixed” if needed.
II. Poverty and Welfare
Key concept: Income transfers, transfers of income from some individuals in the economy to
other individuals. This is generally done by way of the government.
A. The Low-Income Population. To define poverty, the government devised a system
beginning in 1963 that defined poverty based on family income in comparison to the
cost of a nutritious food plan. All families whose income level was not at least a three
times larger than the food plan were classified as below the poverty line. Since 1969 the
government has revised the formula based on changes in the consumer price index
(CPI). In an attempt to assist these families, the government made transfer payments to
them in the form of programs like food stamps and housing vouchers.
B. The Antipoverty Budget. In an effort to resolve some of the most pressing problems of
poverty, the federal government has established a variety of programs. The 2005
budget allocated about $396 billion, or about one-sixth of all federal expenditures, to
programs that support persons of limited income (scholarships included). Of this
amount, $188 billion, or almost half, was for Medicaid, which funds medical services to
the poor. The states were expected to contribute an additional $142 billion to Medicaid.
C.
Basic Welfare. Aid to Families with Dependent Children (AFDC) provided aid to
children in poverty. This program was administered by state governments but was
financed by the federal government. This program was eliminated by the Welfare
Reform Act of 1996 and replaced with Temporary Assistance to Needy Families
(TANF). TANF is a state-administered bloc grant program. The states, not the national
government, now bear the burden of any increased welfare spending. The Welfare
Reform Act of 1996 had several key components. Importantly it provided for
devolution of the welfare system. Most welfare recipients are now limited to two years
of assistance at one time, with a lifetime limit of five years. The act sought to reduce the
number of people receiving benefits and in fact the number has been cut about in half.
D. Welfare Controversies. Basic welfare is often criticized on several grounds. Some
believe it reduces the incentive to find work. Others say it is anti-marriage because it
makes it easier for unmarried mothers to get by. Finally, some may dislike that fact
that so many recipients are members of minority groups.
E. Other Forms of Government Assistance.
Supplemental Security Income (SSI) was established as part of Social Security in 1974
to provide a minimum income for the aged, the blind, and the disabled. Food Stamps
are designed to help provide adequate nutrition for low-income families. The program
began as a twofold mission to help farmers to sell surplus products and to eliminate
malnutrition. The Earned Income Tax Credit (EITC) helps lower-income workers by
providing a rebate on Social Security taxes.
F.
Homelessness—Still a Problem. The problem of homelessness continues to be an
important one, and many advocates for the homeless argue that the Welfare Reform
Act has exacerbated the problem. Estimates are that on any given night there are
anywhere from 230,000 to 750,000 people who are homeless. The fastest growing subgroup of the homeless is families. The debate surrounding the policy issue of
homelessness is couched in ideological terms, as are the solutions to this problem.
III. Crime in the Twenty-First Century
A. Crime in American History. Crime has always been considered a problem in American
society. After rising for many years, violent crime rates have come down over the last
ten years. The reasons for this are not clear. One explanation might be the large
number of perpetrators who have been sent to prison, putting them out of commission.
High spending on law enforcement has also been suggested as a reason. One study
even claimed that legalized abortion has had a major effect by reducing the population
likely to commit crimes.
B. Federal Drug Policy. One of the major causes of crime in the U.S. is the use and sale of
illegal drugs. Illegal drug sales can result in violence because of turf wars between
rival drug gangs, because dealers operate outside the justice system and therefore
resort to violence to settle disputes, and because drug users may resort to crime to
finance their drugs. Money spent on federal drug interdiction programs had not met
with much success, as illegal drug consumption in the U.S. has remained steady. State
and local governments, however, have been attempting new remedies to curtail the
drug problem. One strategy includes sentencing drug offenders to rehabilitation,
rather than prison.
C. Confronting Terrorism. Probably the most devastating type of crime is terrorism
because of its potential to inflict violence on thousands of victims. After the attacks of
September 11, 2001, the federal government enacted many policies in an effort to
combat terrorism. Some policies enjoyed widespread public support; others did not.
What seems clear, however, is that counter-terrorism strategies will necessarily be a
part of federal government policy for years to come.
IV. Environmental Policy
Concern about pollution has made environmental policy an important part of domestic
policy.
A. Cleaning Up the Air and Water. The public had a growing awareness of
environmental problems throughout the 1970s and 1980s. Major environmental
problems like oil spills and toxic waste sites have led the government to formulate
long-term policy aimed at protecting the environment without causing major damage
to the economy. The following polices reflect the concern the government has had for
the need to protect the environment.
1.
The National Environmental Policy Act. This was enacted in 1969 in an attempt to
set national standards for assessing the impact that major federal projects
(construction of roads, buildings, etc.) would have on the environment. Such
projects could not be started without first receiving an environmental impact
statement (EIS).
2.
Curbing Air Pollution. The 1990 amendments to the Clean Air Act of 1963
constitute a comprehensive policy mandating cleaner air in urban areas. Utility
plant emission levels are monitored and the plants must significantly reduce the
amount of carbon monoxide emissions. Automobile manufacturers must reduce
emissions of nitrogen oxide progressively until 2007.
3.
Water Pollution. The Clean Water Act of 1972 amended the Federal Water
Pollution Control Act of 1948. The Clean Water Act sought to make waters safe for
swimming, protect fish and wildlife, and eliminate the discharge of pollutants into
the water. The Clean Water Act has proven controversial, however, because of its
broad definition of “wetlands” (which are subject to prohibitions on filling and
dredging) and because of the “migratory bird rule” (which ruled any waters
suitable for use by migratory birds were subject to regulation as wetlands).
V. The Politics of Economic Decision Making
Fiscal policy is concerned with achieving economic policy goals through changes in
spending or levels of taxation.
A. Fiscal Policy
1.
Keynesian Economics. Fiscal policy is typically based on the ideas of the British
economist John Maynard Keynes (1883–1946). Keynes believed that after falling into
a recession or depression, a modern economy may become trapped in an ongoing
state of less than full employment.
a.
Government Spending. Therefore, in a recession or depression, the government
should engage in spending to make up for the spending that is not happening in
the private sector.
b.
Government Borrowing. For this to work, the spending must be paid for by
borrowing, not new taxes. In other words, the government must run a budget
deficit. The borrowing undertaken by the government makes up for the
borrowing that is not happening in the private sector.
c.
Discretionary Fiscal Policy. This is the discretionary—voluntary—use of fiscal
policy to fine-tune the economy. John F. Kennedy was the first president to
explicitly accept Keynesian economics, and he proposed a tax cut in line with the
theory. The tax cut proved to be a successful economic stimulus.
B. Deficit Spending and the Public Debt
The government funds its deficit primarily by selling U.S. treasury bonds. Twenty
years ago, only 15 percent of these bonds were held abroad. Today the figure is 40
percent.
1.
The Public Debt in Perspective. Key concept: Net public debt, the accumulation of all
past federal government deficits; the total amount owed by the federal government
to individuals, businesses, and foreigners. (It does not include what the government
owes to itself.) We measure the seriousness of the net public debt by measuring it
against the gross domestic product (GDP), the dollar value of all final goods and
services produced in a one-year period.
2.
Are We Always in Debt? From 1960 until the last few years of the twentieth century,
the federal government spent more than it received in all but two years. Politicians
have been happy to implement Keynesianism during recessions, but shy away from
it during booms. In 1993, however, president Bill Clinton deliberately obtained a tax
increase as the nation was entering a boom. The apparent results of the policy were
quite beneficial. From 1998 to 2002, the government actually ran a budget surplus.
Since the dot-com bust and the 2001-2002 recession, however, George W. Bush has
followed a policy of high spending and tax cuts that have increased the budget
deficit greatly.
C. Monetary Policy
Key concept: Monetary policy, the utilization of changes in the amount of money in
circulation to alter credit markets, employment, and the rate of inflation.
1.
Organization of the Federal Reserve System. The Federal Reserve System, or Fed, sets
monetary policy, not the president or Congress. The key body for carrying out the
policy is the Federal Open Market Committee.
2.
Loose and Tight Monetary Policies. The Fed implements policy by increasing or
reducing the rate of growth of the money supply. Increasing the rate of growth is
loose monetary policy. Reducing the rate is tight monetary policy.
3.
Time Lags for Monetary Policy. Like fiscal policy, monetary policy has a problem
with time lags, but the Fed can make a policy change more quickly than Congress.
VI. The Politics of Taxation
Currently, Americans pay taxes that total to somewhat less than 30 percent of the GDP.
A. Federal Income Tax Rates. Not all of your income is taxed at the same rate. The first few
dollars you make are not taxed at all. The highest rate is imposed on the “last” dollar you
make. This highest rate is the marginal tax rate. High marginal tax rates inspire major
efforts to avoid the taxes.
B. Loopholes and Lowered Taxes. Special interests may lobby Congress for “loopholes’ that
will allow them to shelter income from taxation. Loopholes make the tax system
dauntingly complex.
1.
Progressive and Regressive Taxation. Key concepts: Progressive tax, a tax that rises
in percentage terms as incomes rise. Regressive tax, a tax that falls in percentage
terms as incomes rise.
2.
Who Pays? Liberals tend to favor progressive taxes. Conservatives either favor taxes
that are less progressive, or even flat or regressive. The following taxes are
progressive: federal and (most) state income taxes, the federal corporate income tax,
and the estate tax. The following taxes are regressive: the Social Security tax, the
Medicare tax, state sales taxes, and the local property tax. Taken as a whole the tax
system is probably slightly progressive.
VII. The Social Security Problem
Social Security was established in 1935 with the intent of providing a type of insurance for
a large segment of the public. Employees and their employers pay a tax on a percentage of
the employees’ wages.
A. Social Security is Not A Pension Fund.
However, unlike private insurance programs where the individual insured makes
payments in to a account for his or her own policy, the money paid into the Social
Security program is used to provide benefits for people who have already retired, or who
are qualified to receive funds.
B. Workers Per Retiree.
Initially for every recipient of Social Security there were forty workers paying into the
general fund—a one-to-forty ratio. Today, the ratio is more like one-to-three, and it will
get worse in future years. The ballooning cost of Medicare, however, may strain the
system even more than the cost of Social Security.
C. What Will It Take to Salvage Social Security?
1.
Raise Taxes. One proposal for fixing Social Security is to raise taxes. This could be
accomplished by increasing the percentage of taxes withheld, or by eliminating the
current cap on wages on which the payroll tax is withheld. Such proposals, however,
would not provide a complete fix.
2.
Other Options. Another proposal is to reduce benefit payouts. This could be done by
increasing the age of full eligibility to 70 or by imposing a means test for benefits.
Another proposal is to reform immigration policies so that more immigrants are
admitted to pay the tax.
VIII. Features
A. At Issue: Should Social Security Be Partially Privatized?
One proposal to reform Social Security, in the hopes of increasing the implicit rate of
return on contributions, is a partial privatization plan, whereby workers could opt to
take 2 percent of their Social Security payroll tax and invest to build their own
retirement. This would mean that people could have some control over their
retirement nest egg, but would not completely jeopardize their retirement income.
There are numerous critics of this plan. The biggest problem with it is that it diverts
funds that would be paid to today’s retirees. Keeping our promise to the currently
retired plus adding a privatized system could actually cost vast sums of money,
forcing up taxes.