janda.chapter 17 challenge of democracy economic policy

8/11/2019 Janda.chapter 17 Challenge of Democracy Economic Policy

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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 nationalbudget 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


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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.



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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 financialmarkets are informally efficient



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Keynesian Theory

John Maynard Keynes

Business cycles stem from imbalances between

aggregate demand and productive capacity Productive capacitygross domestic product

Government could stabilize economy by controlling level

of aggregate demand

Aggregate demand can be adjusted through fiscal andmonetary policies

Low demand: government spend more money or cut taxes

Demand too great: government spend less or raise taxes



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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)



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Dueling Economists on YouTube



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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



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Monetary Policy (cont.) 2010 Dodd-Frank financial reform bill granted even

greater powers to the Fed to regulate large complexfinancial firms

Ways the Fed controls money supply

Sells securities, takes money out of circulation, raisinginterest rate

Buys securities, process in reverse, lowers interest rate

Sets federal funds raterate banks charge oneanother for overnight loans

Less frequently, may change its discount rate

Can change its reserve requirement



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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 ChairCritical player in economic affairs

Ben BernankeStretched Feds authority during financial crisis

of 2008



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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



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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



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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



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The Nature of the Budget

Budget of the United States Governmentannual plan

Applies to next fiscal yearOctober 1 to September 30

Defines budget authority and outlays Receiptsexpected tax and revenues

Deficitdifference between receipts and outlays

National debtsum of all unpaid government deficits



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Preparing the Presidents Budget

The Office of Management and Budget (OMB)

oversees process

OMB initiates process in spring, agencies preparebudgets in summer and submit to OMB in fall, analysts

review requests, negotiations until budget goes to printer

Proposed budget submitted to Congress



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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



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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)



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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



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Congress allowed caps on discretionary spending to

expire at end of 2002

Gramm-Rudman-Hollings Balanced Budget andEmergency Deficit Control Act in 1985

Law utter failure, deficit targets eliminated in 1990

Balanced budget amendment (BBA) introduced again

in 2011 but failed



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Tax Policies

Reform

Reform proposals influenced by interest groups

Pre-198714 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 morebrackets, moved to more progressive tax structure



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Tax Policies

Reform (cont.)

George W. Bush pushed Congress to pass tax cuts

Reduced revenues increased deficits

Economic downturn, homeland defense, and militaryexpenses compounded problem

Bushs last budgetover a trillion dollars deficit

Deficit continued to grow under Obama

2012, Obama campaigned to restore 39.6 tax bracketfor highest tax bracket



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Tax Policies

Comparing Tax Burdens

Tax burden on U.S. citizens has decreased since

1950s

Tax burden not large compared to other democraticnations

Almost every democratic nation taxes more heavily than

the U.S. does



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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 goesup

Earmarks greatly increased until early 1990s

Congress declared moratorium on earmarks after 2010

election

Some members repackaging them as special funds



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Spending Policies

and Uncontrollable Spending

Earmarks are discretionary outlays

Most government spending is mandatory outlays and

uncontrollable without change in law authorizingprogram

Politics argue against large-scale reductions



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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



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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



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FIGURE 17.5 Distribution of Family Income over Time

T i S di d


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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 distortsgovernments efforts to promote equality


T i S di d


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Economic Equality Democracy and Equality

String of Gallup polls from 1985 to 2008:

Clear majority said distribution of wealth not fair and favor

some redistributionbut 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 understandinequities of national tax system

Economic policy determined through pluralist politics


janda.chapter 17 challenge of democracy economic policy

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