Economic Policy

Chapter 18Chapter 18
EconomicEconomic
PolicyPolicy

Copyright © 2011 CengageCopyright © 2011 Cengage
 WHO GOVERNS?WHO GOVERNS?
1.1. Who in the federal government canWho in the federal government can
make our economy strong?make our economy strong?
2.2. Who was responsible for the recession?Who was responsible for the recession?
 TO WHAT ENDS?TO WHAT ENDS?
1.1. Why does the federal government everWhy does the federal government ever
have a budget deficit?have a budget deficit?
2.2. How do you end a recession?How do you end a recession?

The Politics of EconomicThe Politics of Economic
ProsperityProsperity
 Majoritarian politicsMajoritarian politics
 Pocketbook IssuesPocketbook Issues
• National levelNational level
• Individual levelIndividual level
 What Politicians Try to DoWhat Politicians Try to Do
• UnemploymentUnemployment
• InflationInflation
• Interest ratesInterest rates

Figure 18.1 Federal Budget DeficitFigure 18.1 Federal Budget Deficit
(or Surplus)(or Surplus)
Source: Budget of the U.S. Government, FY 2009 updated by OMB’s Mid-Session Review, July 2009 © 2003, AAAS.
Reprinted with permission

The Politics of Taxing andThe Politics of Taxing and
SpendingSpending
 Voters wantVoters want
• ProsperityProsperity
• Lower taxesLower taxes
• Less debtLess debt
• New/continued programsNew/continued programs
 Objectives areObjectives are
inconsistentinconsistent
During the recession,
people, including middle
class workers, line up at
the unemployment office.
p. 490 Source: Yellow
Dog Productions/ Getty
Images

Economic Theories and PoliticalEconomic Theories and Political
NeedsNeeds
 MonetarismMonetarism
 KeynesianismKeynesianism
 Economic PlanningEconomic Planning
 Supply-side Tax CutsSupply-side Tax Cuts
 DID THE FEDERAL GOVERNMENTDID THE FEDERAL GOVERNMENT
END THE RECESSION?END THE RECESSION?

The Machinery of EconomicThe Machinery of Economic
Policy MakingPolicy Making
 The FedThe Fed
• Monetary policyMonetary policy – alters– alters
the supply of moneythe supply of money
and interest ratesand interest rates
 CongressCongress
• Fiscal policyFiscal policy – uses tax– uses tax
and spending lawsand spending laws
 GlobalizationGlobalization
Ben Bernanke, Chairman of
the Federal Reserve, speaks
to a congressional
committee. p. 495 Source:
Mark Wilson/ Getty Images

Milton
Friedman
John
Maynard
Keynes
John Kenneth
Galbraith
Arthur B. Laffer
Karen Vismara/
Black Star
Bettmann/Corbis
Bettmann/Corbis
Corbis/Corbis Sygma

Spending MoneySpending Money
 Conflicting interestsConflicting interests
• Majoritarian politicsMajoritarian politics
• Client politicsClient politics
• Interest group politicsInterest group politics
 Public OpinionPublic Opinion
 Politicians’ appealsPoliticians’ appeals

The BudgetThe Budget
 BudgetBudget
 Fiscal YearFiscal Year –– October 1 through theOctober 1 through the
following September 30 (federal)following September 30 (federal)
 Budget resolutionBudget resolution –– A congressionalA congressional
decision that states the maximum amountdecision that states the maximum amount
of money the government should spendof money the government should spend
 EntitlementsEntitlements -- A claim for governmentA claim for government
funds that cannot be changed withoutfunds that cannot be changed without
violating the rights of the claimantviolating the rights of the claimant

Reducing SpendingReducing Spending
 Congressional Budget Act of 1974Congressional Budget Act of 1974
 Balanced Budget Act of 1985Balanced Budget Act of 1985
(Gramm-Rudman Act)(Gramm-Rudman Act)
• Sequester – automatic spending cutsSequester – automatic spending cuts
 Budget Enforcement Act of 1990Budget Enforcement Act of 1990
• Limits on discretionary spendingLimits on discretionary spending

Figure 18.2 Federal OutlaysFigure 18.2 Federal Outlays
in 2008in 2008
Source: Office of
Management and Budget,
Mid-Season Review, 2009.

Figure 18.2 Federal RevenuesFigure 18.2 Federal Revenues
in 2008in 2008
Source: Office of
Management and Budget,
Mid-Season Review, 2009.

Figure 18.3 Social Security andFigure 18.3 Social Security and
Medicare Cost as a % of GDPMedicare Cost as a % of GDP
p. 498
Source: Trustees’
Report, 2009.

Levying TaxesLevying Taxes
 Majoritarian politicsMajoritarian politics
• Modest tax burdenModest tax burden
• Minimize cheatingMinimize cheating
 Client politicsClient politics
• LoopholesLoopholes
 Rise in the Income TaxRise in the Income Tax
• Sixteenth AmendmentSixteenth Amendment
• Tax Reform Act of 1986Tax Reform Act of 1986
• Tax increase of 1993Tax increase of 1993
• Tax cuts of 2002Tax cuts of 2002

Figure 18.4 TaxFigure 18.4 Tax
Burdens inBurdens in
Democratic NationsDemocratic Nations
(Taxes as a(Taxes as a
Percentage ofPercentage of
Income of a FamilyIncome of a Family
with Two Children)with Two Children)
Source: Statistical Abstract of the United
States, 2003, Table 1344.

Figure 18.5 Federal Taxes on Income,Figure 18.5 Federal Taxes on Income,
Top Percentage Rates 1913-2002Top Percentage Rates 1913-2002
Source: Updated from Congressional Quarterly Weekly Report (September 18, 1993), 2488.

M E M O R A N D U MM E M O R A N D U M
To:To: Elizabeth Gilbert, chairperson, Council of EconomicsElizabeth Gilbert, chairperson, Council of Economics
From:From: Edward Larson, White House speechwriterEdward Larson, White House speechwriter
Subject:Subject: Flat tax proposalFlat tax proposal
The President would like your advice on whether toThe President would like your advice on whether to
endorse a flat tax. His likely opponent is pushing thisendorse a flat tax. His likely opponent is pushing this
issue.issue.
WHAT WOULD YOU DO?WHAT WOULD YOU DO?

Arguments for:Arguments for:
1. A flat tax is fair because it treats all income groups the1. A flat tax is fair because it treats all income groups the
same. We could leave the lowest income group with nosame. We could leave the lowest income group with no
taxes.taxes.
2. With a flat tax, we could eliminate almost all deductions2. With a flat tax, we could eliminate almost all deductions
and loopholes from the tax code.and loopholes from the tax code.
3. Countries with a flat tax, such as Lithuania, have achieved3. Countries with a flat tax, such as Lithuania, have achieved
great economic prosperity.great economic prosperity.

Arguments against:Arguments against:
1. A flat tax is unfair because it treats all income groups the1. A flat tax is unfair because it treats all income groups the
same. The rich should be taxed more heavily.same. The rich should be taxed more heavily.
2. Many tax deductions, such as the one for home mortgages,2. Many tax deductions, such as the one for home mortgages,
are desirable.are desirable.
3. We could eliminate undesirable tax loopholes without3. We could eliminate undesirable tax loopholes without
creating a flat tax.creating a flat tax.

Your decision:Your decision:
Support?Support?
Oppose?Oppose?

Economic Policy

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