Chapter 17

ECONOMIC
POLICY
Learning Outcomes
17.1 Compare and contrast three theories of
market economics: laissez-faire, Keynesian, and
supply-side.
17.2 Describe the process by which the national
budget is prepared and passed into law and the
reforms undertaken by Congress to balance the
budget.
17.3 Identify the objectives of tax policies and
explain why tax reform is difficult.

Copyright 2014 Cengage Learning 2
Learning Outcomes
17.4 Identify the major areas of government
outlays and explain the role of incremental
budgeting and uncontrollable spending on the
growth of government spending.
17.5 Identify the origins of the income tax, trace
the influence of government spending and taxing
policies on inequality, and examine these policies
from the majoritarian and pluralist perspectives.
Copyright 2014 Cengage Learning 3
Theories of Economic Policy
Laissez-Faire Economics
Absence of government control
Strict advocates maintain government interference with
business obstructs workings of the free market
Mainstream economists today favor market principles but
recognize that government can sometimes improve
market outcomes
Efficient market hypothesis has held that financial
markets are informally efficient
Copyright 2014 Cengage Learning 4
Theories of Economic Policy
Keynesian Theory
John Maynard Keynes
Business cycles stem from imbalances between
aggregate demand and productive capacity
Productive capacity gross domestic product
Government could stabilize economy by controlling level
of aggregate demand
Aggregate demand can be adjusted through fiscal and
monetary policies
Low demand: government spend more money or cut taxes
Demand too great: government spend less or raise taxes

Copyright 2014 Cengage Learning 5
Theories of Economic Policy
Keynesian Theory (cont.)
Capitalist countries have widely adopted Keynesian
theory in some form
Employment Act in 1946, reflects Keynesian theory
Established government responsibility for economy
Tremendous effect on government economic policy
Council of Economic Advisors (CEA)
Keynes-Hayek: debate in 2012 election
Obama auto industry bailout (Keynes)
Romney Let Detroit Go Bankrupt (Hayek)


Copyright 2014 Cengage Learning 6
Dueling Economists on YouTube
Copyright 2014 Cengage Learning 7
Theories of Economic Policy
Monetary Policy
Monetarists, such as Nobel Laureate Milton Friedman,
argue that government can control the economys
performance simply by controlling the nations money
supply
Monetary policies are under control of Federal Reserve
System in U.S.
Three goals:
Controlling inflation
Maintaining maximum employment
Insuring moderate interest rates


Copyright 2014 Cengage Learning 8
Theories of Economic Policy
Monetary Policy (cont.)
2010 Dodd-Frank financial reform bill granted even
greater powers to the Fed to regulate large complex
financial firms
Ways the Fed controls money supply
Sells securities, takes money out of circulation, raising
interest rate
Buys securities, process in reverse, lowers interest rate
Sets federal funds rate rate banks charge one
another for overnight loans
Less frequently, may change its discount rate
Can change its reserve requirement
Copyright 2014 Cengage Learning 9
Theories of Economic Policy
Monetary Policy (cont.)
Formally, president responsible for state of the
economy and voters hold him accountable
President neither determines interest rates (Fed does)
nor controls spending (Congress does)
Feds activities are essential parts of governments
overall economic policy but lie outside presidents control
and in hands of Fed chair
Fed Chair Critical player in economic affairs
Ben Bernanke Stretched Feds authority during financial crisis
of 2008


Copyright 2014 Cengage Learning 10
Theories of Economic Policy
Supply-Side Economics
Stimulate investment through tax cuts and less
government regulation of business
Reaganomics
Economic Recover Tax Act of 1981
Tax cuts
Cuts in spending for social programs
Deregulation
Increases in defense spending


Copyright 2014 Cengage Learning 11
Theories of Economic Policy
Supply-Side Economics (cont.)
How Well Did Reaganomics Work?
Worked as expected, except deficit
Inflation dropped:13% in 1981 to 3% by 1983
Due more to Fed chair Paul Volckers actions
Deregulated business
Unemployment increased to 9.6%
Didnt reduce budget deficit


Copyright 2014 Cengage Learning 12
Public Policy and the Budget
Congressional budgeting
Congress in charge of budget until 1921
Today, President prepares budget, Congress
approves it
Budget and Accounting Act of 1921
Established Bureau of the Budget (now Office of
Management and Budget) to prepare presidents budget
to be submitted to Congress each January

Copyright 2014 Cengage Learning 13
Public Policy and the Budget
The Nature of the Budget
Budget of the United States Government annual plan
Applies to next fiscal year October 1 to September 30
Defines budget authority and outlays
Receipts expected tax and revenues
Deficit difference between receipts and outlays
National debt sum of all unpaid government deficits
Copyright 2014 Cengage Learning 14
Public Policy and the Budget
Preparing the Presidents Budget
The Office of Management and Budget (OMB)
oversees process
OMB initiates process in spring, agencies prepare
budgets in summer and submit to OMB in fall, analysts
review requests, negotiations until budget goes to printer
Proposed budget submitted to Congress

Copyright 2014 Cengage Learning 15
Public Policy and the Budget
Passing the Congressional Budget
The Traditional Procedure
Tax committees
Ways and Means in the House
Finance in the Senate
Authorization committees
Approximately 20 in House; Senate 15
Appropriations committees: House and Senate
More powerful than authorization committees
Copyright 2014 Cengage Learning 16
Public Policy and the Budget
Passing the Congressional Budget (contd)
Two serious problems in budgeting process
Spending process is complex
No one is responsible for budget as a whole
Budget committees supervise comprehensive review
process aided by Congressional Budget Office (CBO)

Copyright 2014 Cengage Learning 17
Public Policy and the Budget
Passing the Congressional Budget (contd)
Congress tried twice to pass Budget Enforcement Act
(BEA) of 1990
Defined spending
Mandatory spending
Discretionary spending
Previous laws paved way for Clintons Balanced
Budget Act of 1997 (BBA)
Led to balanced budget and produced a surplus


Copyright 2014 Cengage Learning 18
Public Policy and the Budget
Passing the Congressional Budget (contd)
Congress allowed caps on discretionary spending to
expire at end of 2002
Gramm-Rudman-Hollings Balanced Budget and
Emergency Deficit Control Act in 1985
Law utter failure, deficit targets eliminated in 1990
Balanced budget amendment (BBA) introduced again
in 2011 but failed



Copyright 2014 Cengage Learning 19
Tax Policies
Reform
Reform proposals influenced by interest groups
Pre-1987 14 income brackets
President Reagan reduced to two
Flat tax violates principle of progressive taxation
Progressive taxation allows government to redistribute
wealth and promote economic equality
Presidents G.H.W. Bush and Clinton added two more
brackets, moved to more progressive tax structure
Copyright 2014 Cengage Learning 20
Tax Policies
Reform (cont.)
George W. Bush pushed Congress to pass tax cuts
Reduced revenues increased deficits
Economic downturn, homeland defense, and military
expenses compounded problem
Bushs last budget over a trillion dollars deficit
Deficit continued to grow under Obama
2012, Obama campaigned to restore 39.6 tax bracket
for highest tax bracket

Copyright 2014 Cengage Learning 21
Tax Policies
Comparing Tax Burdens
Tax burden on U.S. citizens has decreased since
1950s
Tax burden not large compared to other democratic
nations
Almost every democratic nation taxes more heavily than
the U.S. does
Copyright 2014 Cengage Learning 22
Copyright 2014 Cengage Learning 23
Copyright 2014 Cengage Learning 24
Spending Policies
Incremental Budgeting
Agencies submit budgets based on previous year
Congress rarely looks at base budget items
Few agencies ever cut back, spending continually goes
up
Earmarks greatly increased until early 1990s
Congress declared moratorium on earmarks after 2010
election
Some members repackaging them as special funds
Copyright 2014 Cengage Learning 25
Spending Policies
and Uncontrollable Spending
Earmarks are discretionary outlays
Most government spending is mandatory outlays and
uncontrollable without change in law authorizing
program
Politics argue against large-scale reductions
Copyright 2014 Cengage Learning 26
Taxing, Spending, and
Economic Equality
Government Effects on Economic Equality
Do government spending policies have measurable
effect on income inequality?
Government payments to individuals: transfer
payments
Dont always go to poor
Farm program: Wealthiest farmers often receive largest
subsidies
Have definite effect on reducing income inequality
National tax policies at all levels have historically
favored those with higher incomes and the wealthy

Copyright 2014 Cengage Learning 27
Copyright 2014 Cengage Learning
28
Taxing, Spending, and
Economic Equality
Effects of Taxing and Spending Policies over
Time
Poorer citizens pay higher percentage of income in
taxes than wealthier citizens
In capitalist system, some degree of inequality is
inevitable
Copyright 2014 Cengage Learning 29
Copyright 2014 Cengage Learning
30
FIGURE 17.5 Distribution of Family Income over Time
Taxing, Spending, and
Economic Equality
Democracy and Equality
U.S. prizes political equality, but economic equality not
as strong
Wealthiest 1% control 35% of nations household wealth
Distribution among ethnic groups alarming
Typical white familys annual income 1.5 times of blacks and
Hispanics
One theory - Pluralist interest group activity distorts
governments efforts to promote equality
Copyright 2014 Cengage Learning 31
Taxing, Spending, and
Economic Equality
Democracy and Equality
String of Gallup polls from 1985 to 2008:
Clear majority said distribution of wealth not fair and favor
some redistribution but not through heavy taxes on rich
Favor national sales tax or weekly lottery
Sales tax, flat tax = regressive effect, promoting inequality
Lottery also contributes to wealth inequality
Poor more willing to chance income than rich
Majoritarians argue most Americans dont understand
inequities of national tax system
Economic policy determined through pluralist politics
Copyright 2014 Cengage Learning 32