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CHAPTER 18 Economic Policy LEARNING OBJECTIVES 1. How do you define “deficit,” “national debt,” and “gross domestic product”? 2. What makes the politics of taxing and spending so difficult? 3. On which programs does the federal government spend most of its money? 4. Who in the federal government can make our economy strong? 5. Why does the federal government ever have a budget deficit? SUMMARY OVERVIEW Since 1960, the government has spent more money than it takes in; the amount it spends in excess of what it takes in each year is called the deficit and the total amount of all deficits is the national debt. Deficits that result in debt are important economically only insofar as the government cannot make the payments on its bonds in a currency that people regard as stable and valuable. Today’s debates about deficit spending and debt accumulation are so rancorous in part because they have taken shape in the midst of a weak economy. The debates are also made more intense by the fiscal challenges that policymakers see just over the horizon. The American government borrows whenever it needs the money without much regard for what it gets. Two proposals have been made to combat the nation’s debt: cutting spending and raising taxes; neither option is seen as a viable option. Voters seem to respond more to the condition of the national economy than to their own personal finances. However, it is by no means clear that the federal government can or will do whatever is necessary to reduce unemployment, cut inflation, lower interest rates, and increase incomes just to win an election. Most voters would like to have three things—lower taxes, less debt, and new programs. The difficulty here is that the policies endorsed are inconsistent with one another. We cannot have lower taxes, no debt, and higher spending on politically popular programs. If we have more spending, we have to pay for it, either with higher taxes or with more borrowing. Ways to improve the economy: 1. Monetarism 2. Keynesianism 3. Planning 4. Supply-side tax cuts © 2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 126 Chapter 18: Economic Policy In our government it is not easy to implement economic reform. The machinery for making decisions about economic matters is complex and not under the president’s full control. Within the executive branch, three people other than the president are of special importance—the chairman of the Council of Economic Advisors, the director of the Office of Management and Budget, and the secretary of the treasury. The Council of Economic Advisors is seen by other executive agencies as the advocate of the opinion of professio nal economists, who despite their differences generally tend to favor reliance on the market. The chief function of the Office of Management and Budget is to prepare estimates of the amount that will be spent by federal agencies, to negotiate with other departments over the size of their budgets, and to make certain that the legislative proposals of these other departments are in accord with the president’s program. The secretary of the treasury provides estimates of the revenue that the government can expect from existing taxes and what will be the result of changing tax laws. The Federal Reserve System (the Fed) is independent of both the president and Congress. Its most important function is to regulate, the supply of money and the price of money. The Fed sets monetary policy, that is, the effort to shape the economy by controlling the amount of money and bank deposits and the interest rates charged for money. Congress is the most important part of the economic policymaking machinery. It must approve all taxes and almost all expenditures; there can be no wage or price controls without its consent; and it has the ability to alter the policy of the nominally independent Federal Reserve Board by threatening to pass laws that would reduce its power. The federal budget is a list of everything the government is going to spend money on, with only slight regard for how much money is available to be spent. The federal budget should be based on first deciding how much money the government is going to spend and then allocating that money among different programs and agencies. There is a big loophole in the current budget process: Nothing in the process requires Congress to tighten the government’s financial belt. Fair tax law generally has been viewed as one that keeps the overall tax burden rather low, requires everyone to pay something, and requires the better-off to pay at a higher rate than the less-well-off. CHAPTER OUTLINE I. The Politics of Economic Prosperity A. What Politicians Try to Do II. The Politics of Taxing and Spending III. Economic Theories and Political Needs A. Monetarism B. Keynesianism C. Planning D. Supply-Side Tax Cuts © 2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 18: Economic Policy IV. The Machinery of Economic Policymaking A. The Fed B. Congress C. Globalization V. Spending Money VI. The Budget VII. Reducing Spending VIII. Levying Taxes A. 127 The Rise of the Income Tax TEACHING TOOLS LEARNING OBJECTIVE 1: HOW DO YOU DEFINE “DEFICIT,” “NATIONAL DEBT,” AND “GROSS DOMESTIC PRODUCT”? Critical Thinking Question Identify deficit, national debt, and gross domestic product (GDP). Include how the three terms are related. In-Class Activity Ask the class to explain how deficit, national debt, and gross domestic product are related in our economy. Lecture Launcher Discuss whether the government should continue to spend outside of its means. LEARNING OBJECTIVE 2: WHAT MAKES THE POLITICS OF TAXING AND SPENDING SO DIFFICULT? Critical Thinking Question Identify the three things that voters want from economic policy; then briefly explain what makes wanting these things so difficult. In-Class Activity Divide the class into four groups. Each group will report out on one of the possible methods to reform the economy. Lecture Launcher Discuss why the two proposed methods of improving the economy—cutting spending or raising taxes—receive such opposition. © 2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 128 Chapter 18: Economic Policy Learning Objective 3: ON WHICH PROGRAMS DOES THE FEDERAL GOVERNMENT SPEND MOST OF ITS MONEY? Critical Thinking Question Identify the programs upon which the federal government spends the majority of its money. In-Class Activity Ask the class which items they feel the government should devote its money to and then discuss why the government devotes its money to the programs it currently does. Lecture Launcher Discuss why the government can get away with overspending on the programs it currently does. (Why don’t the American people demand lessening the national debt?) Learning Objective 4: WHO IN THE FEDERAL GOVERNMENT CAN MAKE OUR ECONOMY STRONG? Critical Thinking Question Describe the role that each of the main economic agencies have in our economy. In-Class Activity Discuss with the class why the president doesn’t just enforce his solution to the economy. Lecture Launcher Discuss with the class how they think the economy can be improved (made strong). Learning Objective 5: WHY DOES THE FEDERAL GOVERNMENT EVER HAVE A BUDGET DEFICIT? Critical Thinking Question Identify, from your text, why the government is unable to lower, or abolish the budget deficit. In-Class Activity Discuss the factors that lead to a budget deficit. Lecture Launcher Discuss why the government has continued to be allowed to produce a budget deficit. © 2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 18: Economic Policy 129 KEY TERMS budget A document that states tax collections, spending levels, and the allocation of spending among purposes. budget resolution A congressional decision that states the maximum amount of money the government should spend. deficit The result of when the government in one year spends more money than it takes in from taxes. discretionary spending Spending that is not required to pay for contracts, interest on the national debt, or entitlement programs such as Social Security. economic planning The belief that government plans, such as wage and price controls or the direction of investment, can improve the economy. entitlements A claim for government funds that cannot be changed without violating the rights of the claimant. fiscal policy Managing the economy by the use of tax and spending laws. fiscal year For the federal government, October 1 through the following September 30. globalization The growing integration of the economies and societies of the world. gross domestic product The total of all goods and services produced in the economy during a given year. Keynesianism The belief the government must manage the economy by spending more money when in a recession and cutting spending when there is inflation. monetarism The belief that inflation occurs when too much money is chasing too few goods. monetary policy Managing the economy by altering the supply of money and interest rates. national debt The total deficit from the first presidency down to the present. sequester Automatic spending cuts. supply-side theory The belief that lower taxes and fewer regulations will stimulate the economy. WEB LINKS Internal Revenue Service: www.irs.gov Tax Foundation: www.taxfoundation.org INSTRUCTOR RESOURCES © 2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 130 Chapter 18: Economic Policy Birnbaum, Jeffrey H., and Alan S. Murray. Showdown at Gucci Gulch. New York: Random House, 1987. Lively journalistic account of the passage of the Tax Reform Act of 1986. Kiewiet, D. Roderick. Macroeconomics and Micropolitics. Chicago: University of Chicago Press, 1983. Argues that citizens vote on the basis of their estimate of national economic conditions as well as their own financial circumstances. Morgenson, Gretchen, and Joshua Rosner. Reckless Endangerment: How Outside Ambition, Greed, and Corruption Led to Economic Armageddon. New York: Times Books/Henry Holt, 2011. The subtitle says it all. Samuelson, Robert J. The Good Life and Its Discontents. New York: Times Books/Random House, 1995. A readable, intelligent account of American economic life since the Second World War. Schick, Allen. The Federal Budget. Washington, D.C.: Brookings Institution, 2000. Excellent overview of how Washington allocates money. Sorkin, Andrew Ross. Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves. New York: Viking, 2009. The captivating tale of how certain top Washington officials and Wall Street leaders reacted to the near-collapse of the financial system. Stein, Herbert, and Murray Foss. The New Illustrated Guide to the American Economy, 3rd ed. Washington, D.C.: American Enterprise Institute, 1999. A vivid collection of graphs, all clearly explained, that describes the American economy and government spending from the 1950s through the 1990s. © 2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.