Chapter 18 ECONOMIC POLICY Theories of Economic Policy Many different theories about how the U.S.
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Transcript Chapter 18 ECONOMIC POLICY Theories of Economic Policy Many different theories about how the U.S.
Chapter 18
ECONOMIC
POLICY
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Theories of Economic Policy
Many different theories about how the
U.S. economy functions
So complex, no one actually knows how it works
How policymakers TAX & SPEND, and loosen and
tighten INTEREST RATES, depends on their
beliefs about how the economy functions and
the proper role of the government in the
economy
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Theories of Economic Policy
Important to understand economic policy in a
market economy
May be called capitalist economies
May have a mix of government-owned enterprises
China claims to have a socialist market economy
What is the government’s role in directing the
economy?
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We Buy More, & We Borrow More
Globalization results in economic
interdependence among nations
Americans buy many goods and services from
other countries
Foreigners purchase U.S. government securities
So, foreigners lend us money to buy their goods
and services
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Foreign Holdings of Federal Debt
Budget of the United States
Fiscal Year 2010
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Laissez-Faire Economics
The ABSCENCE of government control
Economic competition like natural selection – the
strong survive and prosper
ADAM SMITH’S “invisible hand” in
The Wealth of Nations
Efficient market hypothesis similar concept
Laissez-faire economists would have done
nothing regarding 2008 market crash
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Economists Getting Data
for Predictions
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Key Economic Terms
Economic
Aggregate demand
depression
Inflation
Stagflation
Business cycles
Productive capacity
Gross domestic
product (GDP)
Fiscal policy
Monetary policy
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CPI: Consumer Price Index
A measure of inflation calculated by
Bureau of Labor Statistics (BLS)
Based on prices paid for food, clothing, shelter,
transportation, medical services, and other items
needed for daily living
Not a perfect measure
Government uses for cost-of-living adjustments
COLA
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Keynesian Theory
During Great Depression of 1930s,
John Maynard Keynes
theorized business cycles caused by
imbalances between aggregate demand and
productive capacity
Demand exceeds capacity price inflation
Productive capacity exceeds demand output
declines
rising unemployment economic
depression
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Keynesian Theory
Holds that aggregate demand can be adjusted
through combination of
fiscal policies & monetary policies
If demand is low, government should spend
more money or cut taxes
If demand too great, government should spend
less or raise taxes
Most governments have used deficit financing to
combat economic slumps
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Keynesian Theory
Keynesian economics runs counter to Laissez-Faire
economics
An employment act passed in 1946 established principle of
government involvement in economy
Also established Council of Economic Advisors (CEA) to
help the President
Many believe Keynesian principles led to “big government”
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Monetary Policy
Economists may accept Keynesian theory but don’t
see its political utility
Programs hard to end once begun
Taxes easier to cut than to raise
For theory to succeed, government must have ability
to begin and end spending quickly and cut and raise
taxes quickly
Instead, monetarists favor small but steady growth in
amount of money in circulation
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Chairman of the Board
Ben S. Bernanke, appointed chairman of the Federal Reserve Board
February 1, 2006, by President George W. Bush
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Monetary Policy
Under control of the Federal Reserve System, a
system of banks
Led by independent board of governors and a
chairperson, all appointed by the president
Members cannot be removed by president, but
have set terms of 14 years each
System’s ----3 major goals:
1)Controlling inflation
2)Maintaining maximum employment
3)Ensuring moderate interest rates
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The Federal Reserve System
The Fed controls the MONEY SUPPLY,
affecting inflation
Can buy and sell government securities
Sets target for federal funds rate or discount
rate
Can change its reserve requirement for member
banks
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The Federal Reserve
Interest rates should be raised when
economy growing too quickly
Interest rates should be lowered during
sluggish economy
Historically, Fed adjust rates to combat
inflation, not to stimulate economic growth
Does this further interests of wealthy over
those of the poor?
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The Economy
Voters hold president responsible for
state of economy
However, president not completely in
control: Fed controls interest rates and
Congress controls spending
These restrictions support pluralist model of
democracy
A strong economy favors incumbent
party (and vice versa)
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The Chair and the President
Chair of Federal Reserve key economic player
If president wants a change in monetary
policy, must court the chair
Former Fed chair Alan Greenspan’s policies
blamed for 2008 financial crisis
Bush appointed Ben Bernanke in 2006
Bernanke took bold actions to address situation;
reappointed by President Obama
Historical evidence suggests government
actions can smooth out business cycles
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Supply-Side Economics
President Reagan’s answer to stagflation
Supply-siders want to stimulate
investment through tax cuts for the rich
and less government regulation of
business
More production of goods
Increased productivity
Similar to laissez-faire economics
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Reaganomics
Economic Recover Tax Act of 1981
Reduced individual tax rates
Cut the marginal tax rate for highest income
group
President Reagan launched programs to
deregulate business
Also cut spending to some domestic
programs and increased military
spending
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How Well Did Reaganomics Work?
Inflation dropped from over 13 percent in
1981 to three percent by 1983
Due more to Fed chair Paul Volker’s actions
Did deregulate business
Unemployment increased to 9.6 percent
Did not reduce budget deficit
Tax revenues saw massive drop
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Figure 18.1
Budget Deficits and Surpluses over Time
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Figure 18.1
Budget Deficits and Surpluses over Time
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Public Policy and the Budget
Two views on national budget:
B-O-R-I-N-G vs. exciting script for battlefield
Initially Congress in charge of budget
Today, President prepares budget for
Congress to approve
Budget and Accounting Act of 1921
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The Nature of the Budget:
Important Terms
The Budget of the
Budget outlays
United States
Government
Fiscal year
Budget authority
Receipts
Deficit
Public debt
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The Nature of the Budget
President submits proposed budget for the
next fiscal year to Congress at beginning of
year
President Obama’s proposed FY 2010-2100
budget
Budget authority: $3,691 billion
Budget outlays: $3,834 billion
Budget receipts: $2,567 billion
Budget deficit: $1,267 billion
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Public Debt
The sum of all unpaid government
deficits
Feb. 1, 2010, total debt $12.3 trillion
Public debt owed to outside lenders $7.5
trillion
Almost 50 percent of which foreign
Public debt clock:
http://www.brillig.com/debt_clock
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Preparing the President’s Budget
Federal agencies begin working on
budget the previous spring
The Office of Management and Budget
(OMB) oversees process
Federal budget website:
http://www.gpoaccess.gov/usbudget/
Agencies submit budgets to OMB in fall
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Preparing the President’s Budget
OMB reviews and makes recommendations
to president
Revised guidelines sent back to agencies in
summer
Agencies prepare budgets to submit in fall
OMB analysts examine requests and agency
heads lobby presidential advisors
Proposed budget submitted to Congress
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The Traditional Procedure for
Passing the Congressional Budget:
The Committee Structure
Tax committees: Ways and Means in House
and Finance Committee in Senate
Authorization Committees: have jurisdiction
over particular subjects
House has about 20; Senate about 15
Appropriations committees: in both House
and Senate
Thirteen distinct appropriations bills supposed
to be enacted to fund nation’s spending
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The Congressional Budget
Two-step spending process complex
Agencies must have both authorization and
appropriation approval to spend money
Offers many opportunities for lobbying by
special interests – very pluralistic
Different committees in charge of
revenues and spending
No one committee in charge of budget as a
whole
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Three Decades of Budget Reforms
Budget Impoundment and Control Act of
1974 an effort to make process more
majoritarian
Created budget committees, timetables,
and the Congressional Budget Office (CBO)
Annual targets to cut deficit established
in 1980s were not met
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Three Decades of Budget Reforms
Budget Enforcement Act (BEA) of 1990
defined two types of spending:
Mandatory spending for entitlements
Discretionary spending for expenditures
authorized by annual appropriations
Act also established pay-as-you-go (pay-
go) restrictions on spending and caps on
discretionary spending
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Three Decades of Budget Reforms
President George H.W. Bush agreed to
modest tax increases to gain passage of BEA
Deficit Reduction Act of 1993 helped make
more progress in deficit reduction
Previous laws paved way for President
Clinton’s Balanced Budget Act of 1997 (BBA)
Produced budget surplus ahead of schedule
President Obama asked Congress in 2010 to
reinstitute pay-go rules to reduce deficit
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The End of Budgetary Reform,
2000-Present
In early 2000s, President Bush and
Republicans in Congress advocated tax
cuts to return surplus to taxpayers
Congress allowed caps on discretionary
spending and pay requirements to expire
at end of 2002
Has resulted in deficits
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Tax Policies
Revenue side of budget governed by
overall tax policy
May be changed for many reasons:
To adjust revenues to meet outlays
To make tax burden more equitable
To help control economy by raising or
lowering taxes
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Tax Policies
Conflicting philosophies for distributing
cost of government:
Should citizens be taxed on ability to pay or
benefits received?
Tax policies also used to advance social
goals or favor certain industries
So complicated, tax code over 7,000 pages
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Tax Revenues
Almost 95 percent of U.S. tax revenues
from three sources:
Individual income taxes (44 percent)
Social insurance taxes (36 percent)
Corporate income taxes (12 percent)
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Reform
Reform proposals heavily influenced by
interest groups
President Reagan reduced tax brackets from
14 to two in 1987
Approached a flat tax
Reduced progressiveness of tax system
Flat tax violates principle of progressive
taxation
Progressive taxation allows government to
redistribute wealth and promote economic
equality
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We Gave at the Bureaucracy
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Reform
President George H.W. Bush introduced
third tax bracket in 1990
Clinton created fourth bracket in 1993
Both of these changes reduced deficit
President George W. Bush pushed Congress
to pass tax cuts in 2001
Reduced revenues increased deficits
Economic downturn, homeland defense, and
military expenses compounded problem
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Comparing Tax Burdens
Two ways to look at relative tax burden
Compare taxes over time
Compare with rates in other countries
U.S. rates for a family of four with the
median household income around 20
percent from 1950s to present
U.S. tax burden not large when
compared to other democratic nations
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Spending Policies
U.S. FY 2011 budget projects spending over
$3.8 trillion
Largest amount (20 percent of budget)
targeted for national defense
From WWII to FY 1993, defense spending #1
FY 1993 to FY 2009, defense spending #2
Other categories: income security (#3),
Medicare (#4), health (#5), interest on debt
(#6)
Foreign aid only about one percent of total
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Figure 18.2
Federal Spending in 2011, by Function
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Comparing Spending Policies
Comparing relative shares of expenditures
over time shows changes
Defense spending depends on world situations
Cost of Social Security checks and net
interest payments steadily increasing
Eliminating affects of price inflation,
comparisons over time show national
spending stays at about 20 percent
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Figure 18.4
Government Outlays and Receipts
as a Percentage of GDP
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Incremental Budgeting
One explanation for increased
government spending: incremental
budgeting
Agencies submit budgets based on
previous year, plus some new items
Congress rarely looks at base budget items
Once program exists, clientele groups lobby
for continuation
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Earmarks
Earmarks have increased since early
1990s
Two places to track earmarks:
http://earmarks.omb.gov/earmarks-public/
http://www.washingtonwatch.com/blog/200
9/04/12/catalogue-of-fy-2010-earmarks/
Opinions on earmarks depend on
viewpoints on role of elected officials
Representation – earmarks pluralist politics
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Uncontrollable Spending
Earmarks discretionary outlays
Most government spending mandatory
outlays and uncontrollable without a change
in the law authorizing the program
Over 60 percent of 2011 budget basically
uncontrollable
About 15 percent of budget national defense or
homeland security
This leaves only around 15 percent for
discretionary spending
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Public Opinion on Spending
Most favor spending cuts in the abstract
When asked about funding specific
programs, most favored keeping existing
funding levels or slight increases
Especially true for Social Security and
Medicare
Americans want the benefits but don’t
want to raise taxes to pay for them
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Taxing, Spending, and
Economic Equality
Promoting economic equality controversial
Possible only through reductions in economic
freedom though re-distribution of wealth
First income tax used in 1862 to fund Civil War
That tax repealed in 1871
Income tax law passed in 1894 ruled
unconstitutional by Supreme Court in 1875
Sixteenth Amendment (1913) gave national
government power to tax income
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Government Effects on
Economic Equality
Do government spending policies have a
measurable effect on income equality?
Study showed government policies cut
poverty rate in half between 1979 and 2002
Government payments to individuals
transfer payments
Do not always go to the poor
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Fluctuations in Tax Rates
With progressive taxation, more revenue
taken from rich than from poor
Progressivity of tax system varied
substantially between 1979 and 2001
Opponents of progressive taxation
concerned with inequalities
Richest one percent of taxpayers
contributed 40 percent of all taxes in 2007
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Tax Inequities
In some cases, poorer citizens pay higher
percentage of income in taxes than
wealthier citizens
Warren Buffett on tax rates:
http://www.youtube.com/watch?v=Cu5B-2LoC4s
Total tax burden combination of
national, state, and local taxes
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Progressive vs. Regressive Taxes
Not all taxes progressive:
National income tax: progressive
National payroll tax: regressive
Sales tax: regressive
Very low taxes on those whose income
based on capital rather than labor
Municipal bonds not taxed
Unearned income not withheld
Capital gains tax lower than tax on salaries
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Effects of Taxing and Spending
Policies over Time
Income gap between the poorest fifth of
American families and richest fifth grew
between 1966 and 2004
In capitalist system, inequality inevitable
Study of 18 developed countries shows U.S.
has most unequal distribution of income
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Figure 18.6
Distribution of Family Income over Time
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Democracy and Equality
U.S. prizes political equality, but record on
economic equality not as strong
Wealthiest one percent control 33 percent of
household wealth
Typical white family’s annual income 1.5 times
that of both blacks and Hispanics
Does pluralist interest group activity distort
government’s efforts to promote equality?
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Democracy and Equality
Would tax policies change under
majoritarian democracy?
Series of studies show:
A majority see major income inequities but
don’t favor heavy taxes on rich
A majority prefer national sales tax or weekly
lottery; want to pay in increments
Majoritarians believe most Americans don’t
understand national tax system
We will continue current pluralist approach
to taxation
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