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CHAPTER 18Economic Policy seq NL1 \r 0 \h ObjectivesThe purpose of this chapter is to introduce the student to the theories and substance of economic policy. After reading and reviewing the material in this chapter, the student should be able to do each of the following: SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .Explain the economic, substantive, and political reasons for the national debt.2 seq NL_a \r 0 \h .Show how voters have contradictory attitudes regarding their own and others’ economic circumstances. 3 seq NL_a \r 0 \h .List and briefly explain four competing economic theories. Assess the nature and impact of Reaganomics.4 seq NL_a \r 0 \h .List the four major executive-branch agencies involved in setting economic policy and explain the role of each.5 seq NL_a \r 0 \h .Analyze federal fiscal policy in terms of the text’s four categories of policymaking politics.6 seq NL_a \r 0 \h .Trace the history of federal government budgeting practices. seq NL1 \r 0 \h OverviewThree kinds of economic indicators matter to voters. These are the economic health of the nation, the amount and kinds of government spending, and the level and distribution of taxes. Different kinds of politics influence policies for each of these outcomes.The politics of inflation, unemployment, and economic growth tends to be majoritarian. The president is held responsible for national conditions, even though there are only imperfect economic theories to direct clumsy government tools controlled by divided political authorities. Still, national economic health has powerful effects on election outcomes, driven as much by people’s perceptions of national conditions as by their worries about personal finances.When economic ill health occurs in some industries and places but not in others, the politics of economic health is shaped by interest-group politics. Tariff policies are a good illustration of this politics. Firms that import foreign products or sell to foreign nations try to avoid trade restrictions, whereas firms and unions hurt by foreign competition try to have such restrictions imposed.The amount of government spending is only theoretically determined by the budget. In fact, the president and Congress struggle over particular spending bills, whose amounts often reflect interest-group and client pressures.The general shape of federal tax legislation is determined by majoritarian politics, but the specific provisions (especially deductions, exemptions, and exclusions) are the result of client and interest-group politics. The Tax Reform Act of 1986 was a remarkable example of the reassertion of majoritarian politics over client and interest-group pressures. It was made possible by policy entrepreneurs and political incentives. seq NL1 \r 0 \h Chapter Outline with Keyed-in Resources SEQ NLI \r 0 \h I seq NLA \r 0 \h . seq NLA \r 0 \h Reasons for government debt (THEME A: POLITICS AND ECONOMICS)A seq NL1 \r 0 \h .Deficit: spending more than one earns1 seq NL_a \r 0 \h .Financed by selling government bonds to Americans and foreigners2 seq NL_a \r 0 \h .National debt: Total amount of all deficitsB seq NL1 \r 0 \h .Economic reason for debt1 seq NL_a \r 0 \h .Bonds are always repaid.2 seq NL_a \r 0 \h .People want to buy U.S. bonds because the dollar is stable and valuable.3 seq NL_a \r 0 \h .Interest payments must be made each year.a seq NL_1_ \r 0 \h )In 2006, interest was about 8 percent of all federal expenditures.b seq NL_1_ \r 0 \h )Third most expensive program (after social welfare and defense)c seq NL_1_ \r 0 \h )Interest payments equal about 1.7 percent of GDPd) The recession that began in 2007 and continued through 2009 resulted in business failure, increases in unemployment, and a smaller GNP—the cost of government increases due to increased demand for unemployment while tax revenues are reduced due to slowed economic activity.e seq NL_1_ \r 0 \h )Making interest payments may be more difficult as Social Security and Medicare costs increase with an aging population.C seq NL1 \r 0 \h .Substantive argument about debt1 seq NL_a \r 0 \h .Families borrow to buy long-lasting items, such as a home, car, or college education.2 seq NL_a \r 0 \h .Government borrows money when it needs it without thought for long-term benefit.D seq NL1 \r 0 \h .Political opposition to debt1 seq NL_a \r 0 \h .Public is opposed to public debt, so politicians are, too.2 seq NL_a \r 0 \h .Offer contrasting ways to combat it SEQ NL_a \r 0 \h a seq NL_1_ \r 0 \h )Conservatives: Cut spendingb seq NL_1_ \r 0 \h )Liberals: Raise taxes3 seq NL_a \r 0 \h .People do not want cuts in spending, but they also do not want higher taxes; political stalemate usually results.II seq NLA \r 0 \h .The politics of economic prosperity SEQ NL1 \r 0 \h A seq NL1 \r 0 \h .Disputes about economic well-being tend to produce majoritarian politics.1 seq NL_a \r 0 \h .Voters see connections between nation as a whole and their own situations.a seq NL_1_ \r 0 \h )Low-income voters more likely to worry about employment and vote Democratic.b seq NL_1_ \r 0 \h )High-income voters more likely to worry about inflation and vote Republican.2 seq NL_a \r 0 \h .Voters respond more to condition of the national economy than of their own personal finances. SEQ NL_a \r 0 \h a seq NL_1_ \r 0 \h )People understand what government can and cannot be held accountable for.b seq NL_1_ \r 0 \h )People see economic conditions having indirect effects on them even when they are doing well.B seq NL1 \r 0 \h .What politicians try to do SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .Government officials will sometimes use money to affect elections.a seq NL_1_ \r 0 \h )Patronageb seq NL_1_ \r 0 \h )Veterans’ benefitsc seq NL_1_ \r 0 \h )Social Security increases2 seq NL_a \r 0 \h .Government will not always do whatever is economically necessary to win an election.a seq NL_1_ \r 0 \h )Government does not know how to produce all desirable outcomes.b seq NL_1_ \r 0 \h )Economic pressures are often interrelated.3 seq NL_a \r 0 \h .Ideology plays large role in shaping policy choices. SEQ NL_a \r 0 \h a seq NL_1_ \r 0 \h )Democrats focus on reducing unemployment.b seq NL_1_ \r 0 \h )Republicans focus on reducing inflation.III seq NLA \r 0 \h .The politics of taxing and spending SEQ NLA \r 0 \h A seq NL1 \r 0 \h .Majoritarian politics is inconsistent.1 seq NL_a \r 0 \h .Everyone wants general prosperity.2 seq NL_a \r 0 \h .Large majorities want more government spending on popular programs.B seq NL1 \r 0 \h .Voters want conflicting policies: lower taxes, less debt, and new programs.1 seq NL_a \r 0 \h .Lower taxes means less spending or more debt.2 seq NL_a \r 0 \h .More spending means higher taxes or more debt.C seq NL1 \r 0 \h .Key is to raise taxes on “other people.”1 seq NL_a \r 0 \h .“Other people” are always a minority of voters (cigarette smokers, affluent voters).2 seq NL_a \r 0 \h .For example, fund new medical research with tax on cigarettesVI.What caused the 2007–2009 recession?Federal Reserve Bank lowered interest rates.Firms developed new methods for selling mortgages.The government reduced credit requirements for lower income families so that they could put a smaller deposit on a mortgage.Cheap money, combined with these new “subprime” mortgage instruments, produced a housing boom.Investment banks began bundling mortgages together combining secure with subprime, or less secure, mortgages and selling them as “mortgage-backed securities.Stimulated home salesIncreased book value of homesHomeowners borrowed against increased value of their homes.Homeowners used this equity to buy goods and services within the economy which stimulated economic growth.Debt levels for consumers and banks increasedBanks continued to loan money, increasing their vulnerability to any downturn in the value of the real estate market, which was being used to secure the loans.The economic moved into a recession, in part stimulated by increasing fuel costs. Global production costs increased for goods and services, which led to decreased sales.Many homeowners caught in the economic downturn found the estimated value of their real estate had dropped below the value of their mortgages. Many defaulted on their loans.Banks that held these mortgages were told by federal regulators to revalue their holdings. Investors in the banks withdrew their holdings. Many banks and investment companies that supported them could not afford to maintain payments on these investments, so they failed.Consumers’ and investors’ confidence in global economic markets plummeted. Credit markets froze. This led to reduced economic activity and layoffs, which spiraled into a ernment policy exacerbated this economic crisis.Two government-backed corporations, Fannie Mae and Freddie Mac, owned $5 trillion in mortgages.They were actually owned by private investors.Widespread belief was that they would be backed by the federal government.They had mandated that banks issue subprime mortgages to poor people. Many of these people were forced to default on their mortgages, which they could not afford.The federal government took over the bankrupt Fannie Mae and Freddie Mac.Credit FrozeBanks afraid of an economic collapse stopped lending money to preserve their existing capital reserves.Industries that relied on credit to finance purchases of their product, home builders, and automobile companies experienced drastic reduction in sales.The collapse of these two market sectors rippled through the remaining sectors of the economy, resulting in widespread reduction in economic activity.Unemployment rose as firms laid off workers whom they did not need, due to reduced production demands.The stock market, reflecting these economic changes, collapsed II seq NLA \r 0 \h .Economic theories and political needsPresidents select economic advisors whose theories reflect the president’s own economic views.Conservatives tend to emphasize monetarism and supply-side approaches to economic management.Liberals tend to focus on Keynesianism combined with elements of a planned economy SEQ NL1 \r 0 \h B seq NL1 \r 0 \h .Monetarism1 seq NL_a \r 0 \h .Asserts that inflation occurs when there is too much money chasing too few goods (Milton Friedman)2 seq NL_a \r 0 \h .Advocates increasing the money supply at a rate about equal to economic growth and then letting the free market operate3. To combat a recession, monetarist supports cuts in interest rates by the Federal Reserve to stimulate borrowing, which in turn stimulates purchases by consumers, coupled with expansion of business financed by lower interest rates.C seq NL1 \r 0 \h .Keynesianism1 seq NL_a \r 0 \h .Argues that government should create the right level of demand2 seq NL_a \r 0 \h .Assumes that the health of the economy depends on what fraction of their incomes people save or spend3 seq NL_a \r 0 \h .When demand is too low, government should pump money into the economy by spending more than it collects in taxes.4 seq NL_a \r 0 \h .When demand is too high, government should take money out of the economy by increasing taxes or cutting expenditures.D seq NL1 \r 0 \h .Planning1 seq NL_a \r 0 \h .Asserts that the free market is too undependable to ensure economic activity2 seq NL_a \r 0 \h .Government should plan parts of a country’s economic activity.3 seq NL_a \r 0 \h .Wage-price controls (John Kenneth Galbraith)4. In 2008–2009, the federal government began to invest in failing banks. Some planners asserted that the government should assume control of Bank of America and Citibank in order to recover federal investments.E seq NL1 \r 0 \h .Supply-side tax cuts1 seq NL_a \r 0 \h .There is a need for less government interference in the market and lower taxes (Arthur Laffer, Paul Craig Roberts).2 seq NL_a \r 0 \h .Lower taxes would create incentives for work and investment.3 seq NL_a \r 0 \h .Greater investments lead to more jobs.4 seq NL_a \r 0 \h .Increase in productivity will produce more tax revenue for the government.F. Did the federal government end the recession?1 seq NL_a \r 0 \h . Proponents of the 2009 stimulus law argued:Stimulaie consumer activity by giving the public moneySpend more money on state, local, and federal projects to create jobsPay for these programs through increased federal borrowing 2 seq NL_a \r 0 \h . Republicans in Congress opposed these measures.It would take two to three years for government projects to stimulate the economy.Borrowing this money would increase the federal debt.Tax cuts would have the same impact by putting more money into the hands of consumers and businesses.Votes on the 2009 stimulus bill reflected deep partisan division. No Republican in the House voted to support the measure. Three Republican senators voted in favor of the measure.III seq NLA \r 0 \h .The machinery of economic policy making SEQ NLA \r 0 \h A seq NL1 \r 0 \h .Fragmented policy making; not under president’s full control SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .Within the executive branch, numerous organizations influence economic policy. SEQ NL_a \r 0 \h a seq NL_1_ \r 0 \h )Council of Economic Advisers (CEA): members are professional economists sympathetic to the president’s view of economics. SEQ NL_1_ \r 0 \h (1) seq NL_(a) \r 0 \h Forecasts economic trends, analyzes issues(2) seq NL_(a) \r 0 \h Prepares the annual economic report that the president sends to Congressb seq NL_1_ \r 0 \h )Office of Management and Budget (OMB) SEQ NL_1_ \r 0 \h (1) seq NL_(a) \r 0 \h Prepares estimates of amounts to be spent by federal government agencies; negotiates department budgets(2) seq NL_(a) \r 0 \h Ensures that departments’ legislative proposals are compatible with the president’s programc seq NL_1_ \r 0 \h )Secretary of the Treasury reflects the point of view of the financial community. SEQ NL_1_ \r 0 \h (1) seq NL_(a) \r 0 \h Provides estimates of government’s revenues(2) seq NL_(a) \r 0 \h Represents the nation in dealings with bankers and other nationsd seq NL_1_ \r 0 \h )The Federal Reserve Board (the Fed) SEQ NL_1_ \r 0 \h (1) seq NL_(a) \r 0 \h Members are appointed by the president, confirmed by the Senate; serve a nonrenewable fourteen-year term; removable for cause.(2) seq NL_(a) \r 0 \h Chair serves for four years(3) seq NL_(a) \r 0 \h Somewhat independent of both the president and Congress(4) seq NL_(a) \r 0 \h Regulates the supply and price of money(5) seq NL_(a) \r 0 \h Sets monetary policy: the effort to shape the economy by controlling the amount of money and bank deposits and the interest rates charged for moneyB seq NL1 \r 0 \h .Congress 1 seq NL_a \r 0 \h .Most important part of economic policymaking machine2 seq NL_a \r 0 \h .Approves all taxes and almost all expenditures3 seq NL_a \r 0 \h .Consents to wage and price controls4 seq NL_a \r 0 \h .Can alter/influence Fed policy by threatening to reduce its powers5 seq NL_a \r 0 \h .But Congress is also internally fragmented, with numerous committees setting economic policy6 seq NL_a \r 0 \h .Creates fiscal policy when it decides how high taxes should be and how much money the government should spendC seq NL1 \r 0 \h .Effects of claims by interest groups SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .Supporters of free trade find it easy to sell their goods abroad.2 seq NL_a \r 0 \h .Supporters of tariffs find it hard to compete with foreign imports.3 seq NL_a \r 0 \h .NAFTA a victory for free trade, but extension to all Latin American countries was blocked by free-trade opponents.D seq NL1 \r 0 \h .Globalization1 seq NL_a \r 0 \h .Globalization refers to the growing integration of the economies and societies of the world.2 seq NL_a \r 0 \h .Supporters favor globalization because it has increased income, literacy, and standard of living of participants; products are also cheaper.3 seq NL_a \r 0 \h .Opponents object to globalization for a variety of reasons.a seq NL_1_ \r 0 \h )Cheap foreign labor may undercut wages of American workers.b seq NL_1_ \r 0 \h )Selfish corporate interests exploit people in poor countries.c seq NL_1_ \r 0 \h )Local cultures are undermined by global culture.IV seq NLA \r 0 \h .Spending money SEQ NLA \r 0 \h A seq NL1 \r 0 \h .Majoritarian, client, or interest-group politics all result from policy debates.B seq NL1 \r 0 \h .Sources of conflict are reflected in the inconsistencies in public opinion.C seq NL1 \r 0 \h .Politicians have an incentive to make two kinds of appeals: SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .Keep spending down and cut deficit2 seq NL_a \r 0 \h .Support voters’ favorite programsD seq NL1 \r 0 \h .Incompatibility of these appeals is evident in the budget.V seq NLA \r 0 \h .The budget (THEME B: THE BUDGET PROCESS) SEQ NLA \r 0 \h A seq NL1 \r 0 \h .Budget: a document that announces how much the government will collect in taxes and spend in revenues and how those expenditures will be allocated among various programsB seq NL1 \r 0 \h .Fiscal year: time period covered by the budget, running from October 1 to September 30 of the following yearC seq NL1 \r 0 \h .Federal budget in practice: Record of expenditures instead of allocation of revenue SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .No federal budget before 19212 seq NL_a \r 0 \h .No unified presidential budget until the 1930s3 seq NL_a \r 0 \h .Congressional committees continued to respond independently..D seq NL1 \r 0 \h .Congressional Budget Act of 1974: established procedures to reform past practices SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .President submits budget.2 seq NL_a \r 0 \h .House and Senate budget committees analyze the budget, with input from the Congressional Budget Office.3 seq NL_a \r 0 \h .Each committee proposes to its house a budget resolution that sets a total budget ceiling and ceilings for each of several spending areas.4 seq NL_a \r 0 \h .Congress is supposed to adopt these resolutions to guide its budget debates.5 seq NL_a \r 0 \h .Congress considers appropriations bills and sees whether they are congruent with the budget resolution.6 seq NL_a \r 0 \h .Appropriations bills cannot make big changes in the budget because approximately two-thirds of government spending is on entitlements.7 seq NL_a \r 0 \h .Nothing requires Congress to make cuts, but the process has made some links between spending and revenues.8 seq NL_a \r 0 \h .Reagan secured large cuts in 1981 but was unsuccessful in subsequent years.VI seq NLA \r 0 \h .Reducing spending SEQ NLA \r 0 \h A seq NL1 \r 0 \h .Passage of the Gramm-Rudman Balanced Budget Act (1985) placed the first cap on spending. SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .Called for automatic cuts from 1986 to 1991, until the federal deficit disappeared2 seq NL_a \r 0 \h .If there was a lack of agreement between the president and Congress on the total spending level, there would be automatic across-the board cuts (a sequester).3 seq NL_a \r 0 \h .President and Congress still found ways to increase spending.B seq NL1 \r 0 \h .A new budget strategy in 1990 SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .Congress voted for a tax increase.2 seq NL_a \r 0 \h .Enacted Budget Enforcement Act that set limits on discretionary spendinga seq NL_1_ \r 0 \h )If Congress spends more on one discretionary program, then it must cut spending on another discretionary program or raise taxes.b seq NL_1_ \r 0 \h )Law expired in 2001, but in 2007 some members of Congress hoped to revive itVII seq NLA \r 0 \h .Levying taxes SEQ NLA \r 0 \h A seq NL1 \r 0 \h .Tax policy reflects blend of majoritarian and client politics. SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .“What is a ‘fair’ tax law?” (majoritarian politics) SEQ NL_a \r 0 \h 2 seq NL_a \r 0 \h .“How much is in it for me?” (client politics) SEQ NL_a \r 0 \h B seq NL1 \r 0 \h .The rise of the income tax SEQ NL1 \r 0 \h SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .Most revenue was derived from tariffs until ratification of the Sixteenth Amendment (1913).2 seq NL_a \r 0 \h .Taxes then varied with war (when taxes were high) and peace (when taxes were low). SEQ NL_a \r 0 \h 3 seq NL_a \r 0 \h .Rates were progressive: wealthiest individuals paid at higher rate than less affluenta seq NL_1_ \r 0 \h )High rates for the rich were offset by many loopholes (political compromise between Republicans and Democrats).b seq NL_1_ \r 0 \h )Constituencies organized around loopholes.4 seq NL_a \r 0 \h .Tax bills before 1986 dealt more with tax loopholes (deductions) than with rates.5 seq NL_a \r 0 \h .Tax Reform Act of 1986 upset old compromise by changing policy from high rates with big deductions to low rates with smaller deductions.6 seq NL_a \r 0 \h .George H. W. Bush and Clinton increased tax rates but kept deductions low.7 seq NL_a \r 0 \h .George W. Bush had tax cut plan approved by Congress, but cuts will expire in 2010 seq NL1 \r 0 \h Web ResourcesThe Brookings Institution—Economic Studies: brookings.edu/es/es_hp.htmCato Institute: Center on Budget and Policy Priorities: Congressional Budget Office (CBO): Economic Policy Institute: Federal Reserve Board: Federal Spending: Internal Revenue Service (IRS): Library of Economics and Liberty: laureates in economics: of Management and Budget (OMB): omb RAND Corporation: TreasuryDirect, Government Section: t/govt.htmU.S. Department of the Treasury: seq NL1 \r 0 \h Research and Discussion TopicsIs inflation a problem? Older adults often reminisce about low consumer prices of days gone by, yet higher prices today are often offset by higher incomes. Overall, the ratio between prices and income remains relatively the same. However, this ratio can be maintained only when inflation rates are low. When price increases begin to exceed income increases, voters put pressure on politicians to do something about the inflation problem. Have students investigate inflation rates in other countries and discuss what happens to the economy and the political regime when inflation rates rise dramatically. Ask students to interview adults who experienced the double-digit inflation rates of the late 1970s to see how it affected their opinions about economics and politics.Is debt a problem? From time to time, concern over the national debt prompts politicians to place spending-reduction policies on the national agenda. However, history has shown that debt levels have fluctuated over time without causing long-term harm to the economy. Have students discuss the political implication of the national debt by examining the following questions: What are the concerns about long-term debt? What are the options to deficit spending? Are balanced-budget measures feasible or wise? Are voters likely to allow the government to post surpluses, or will they demand tax refunds instead? Eliminate income tax? Most taxpayers do not like paying income taxes. They object not only to the complexity of our tax laws but also to the philosophy of taxing people more when they earn more. From time to time, politicians have considered replacing the progressive income tax with something else, such as a flat tax or a national sales tax. Have students select an alternative tax proposal and discuss whether it would be viable in the current economic and political system. After researching this topic, have students identify the interest groups supporting and opposing the flat-tax or sales-tax policy. seq NL1 \r 0 \h Important TermsbudgetA document that states tax collections, spending levels, and the allocation of spending among purposesbudget resolutionA congressional decision that states the maximum amount of money the government should spenddeficitWhat occurs when the government in one year spends more money than it takes in from taxesdiscretionary spendingSpending that is not required to pay for contracts, interest on the national debt, or entitlement programs such as Social Securityeconomic planningThe belief that government plans, such as wage and price controls or the direction of investment, can improve the economyentitlementsA claim for government funds that cannot be changed without violating the rights of the claimantfiscal policyManaging the economy by the use of tax and spending lawsfiscal year For the federal government, October 1 to September 30globalizationThe growing integration of the economies and societies of the worldgross domestic product The total of all goods and services produced in the economy during a given yearKeynesianismThe belief that the government must manage the economy by spending more money in a recession and cutting spending when there is inflationmonetarismThe belief that inflation occurs when too much money is chasing too few goodsmonetary policyManaging the economy by altering the supply of money and interest ratesnational debtThe total deficit from the first presidency down to the presentReaganomicsThe belief that a combination of monetarism, lower federal spending, and supply-side economics will stimulate the economysequesterAutomatic spending cutssupply-side theoryThe belief that lower taxes and fewer regulations will stimulate the economy seq NL1 \r 0 \h Theme A: Politics and Economics seq NL1 \r 0 \h Instructor ResourcesSandra M. Anglund. Small Business Policy and the American Creed. Westport, CT: Praeger, 2000.Carl Boggs. The End of Politics: Corporate Power and the Decline of the Public Sphere. New York: Guilford Press, 2000.George J. Borjas. Heaven’s Door: Immigration Policy and the American Economy. Princeton, NJ: Princeton University Press, 2001. Kenneth W. Dam. The Rules of the Global Game: A New Look at U.S. International Economic Policymaking. Chicago: University of Chicago Press, 2001. Chris R. Edwards. Downsizing the Federal Government. Washington, D.C.: Cato Institute, 2005.John Ehrenberg. Servants of Wealth: The Right’s Assault on Economic Justice. Lanham, MD: Rowman & Littlefield, 2006.Price Fishback et al. Government and the American Economy: A New History. Chicago: University of Chicago Press, 2007.Jeffrey A. Frankel and Peter R. Orszag, eds. American Economic Policy in the 1990s. Cambridge, MA: MIT Press, 2002. Norton Garfinkle. The American Dream vs. the Gospel of Wealth: The Fight for a Productive Middle-Class Economy. New Haven, CT: Yale University Press, 2006.Martha L. Gibson. Conflict Amid Consensus in American Trade Policy. Washington, D.C.: Georgetown University Press, 2000.Thomas A. Kochan. Restoring the American Dream: A Working Families’ Agenda for America. Cambridge: MIT Press, 2005.Nelson Lichtenstein, ed. American Capitalism: Social Thought and Political Economy in the Twentieth Century. Philadelphia: University of Pennsylvania Press, 2006.Mancur Olson. The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities. New Haven, CT: Yale University Press, 1982.Russell D. Roberts. The Choice: A Fable of Free Trade and Protectionism. 3rd ed. Upper Saddle River, NJ: Pearson/Prentice-Hall, 2007.Gene B. Sperling. The Pro-growth Progressive: An Economic Strategy for Shared Prosperity. New York: Simon & Schuster, 2005.Constantine J. Spiliotes. Vicious Cycle: Presidential Decision Making in the American Political Economy. College Station: Texas A&M University Press, 2002. Maria Vidal de Haymes, Keith M. Kilty, and Elizabeth A. Segal, eds. Latino Poverty in the New Century: Inequalities, Challenges, and Barriers. New York: Haworth Press, 2000. seq NL1 \r 0 \h SummaryPresidential accountability to the voters is a central fact about the federal government’s role in the economy. Unfortunately, the White House cannot control the economy’s progress, because external variables (such as world trade conditions) and the proliferation of economically influential federal agencies can frustrate the proposed fiscal game plan. Furthermore, economic forces are so unpredictable and volatile (a specific policy can easily backfire) that the search for economic prosperity begins to resemble a game of Russian roulette. Accordingly, partisan ideological preferences for a specific economic theory usually shape policy directions on such matters as unemployment, inflation, and reduction of the federal debt.The text discusses four major theories on the management of the economy. SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .Monetarism. Monetarists such as the late Milton Friedman hold that inflation is the result of too much money chasing too few goods. This occurs when government prints too much money. When government tries to stop inflation by decreasing the money supply, unemployment increases. Monetarists hold that rather than adopting these start-and-stop policies, it would be better if government allowed the money supply to increase steadily and consistently at a rate about equal to the growth in the productivity of the economy. This should, however, be the extent of the government’s involvement in the economy.2 seq NL_a \r 0 \h .Keynesianism. For Keynesians, the market will not automatically operate at a full-employment, low-inflation levels. When people spend too little, unemployment results, and government should pump more money into the economy by running a deficit. That is, government should spend more than it takes in. When demand is too great, government should run a surplus. That is, it should take more from the economy than it returns to the economy (through spending). Thus, an activist government fiscal policy is necessary.3 seq NL_a \r 0 \h .Planning (price and wage controls, industrial policy). Economists such as John Kenneth Galbraith feel that large institutions in the economy (corporations and labor unions) have the ability to escape competitive pressures and raise prices, whatever the money supply or level of consumer demand. Thus, the government must control wages and prices. However, with the curbing of inflation in the 1980s and the voluntary lowering of wages and prices, a different type of planning by government was considered. Industrial policy reflected the federal government’s desire to direct investment to declining but vital industries—steel and auto—in imitation of the Japanese model. This model was endorsed by Robert Reich.4 seq NL_a \r 0 \h . seq NL_a \r 0 \h Supply-side tax cuts. This relatively new theory, propounded by people such as Arthur Laffer and Paul Craig Roberts, holds that high taxes create inflation and economic stagnation by removing people’s incentive to work. Thus, cutting tax rates will encourage work and investment and even bring in more tax revenue as economic activity expands. This theory formed the core of Reaganomics.Although economic forecasting and policy implementation are inexact, economists do provide important data to government. Presidents must have economic policies that can reconcile the various perspectives of the voters. seq NL1 \r 0 \h Discussion Questions SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .Why is the president held accountable for the economy? Remember that Congress plays an important role in setting fiscal policy and that the Federal Reserve Board is largely independent in setting monetary policy.2 seq NL_a \r 0 \h .Each of the four theories defined above has played a dominant role in United States economic policy, though each has dominated in a distinct historical period. Under what circumstances would you recommend implementing which theory? What are the particular strengths of each theory? What are the particular weaknesses?3 seq NL_a \r 0 \h .One of the components of Reaganomics is the theory that tax rates take away the incentive to work: people who work more will be penalized because they are unable to keep much of what they earn. Which populations or professions do you think would be most affected by high tax rates? Would high taxes deter individuals within these groups from working or investing? How has this played out in European nations, which have very high tax rates? Have they suffered a loss of economic productivity as these theorists predict?4 seq NL_a \r 0 \h .Do voters base their support of economic policy on what is best for them personally or what is best for the nation as a whole? Is it possible for politicians to convince voters to pay more taxes for the good of the nation? Or do they have to offset the tax increase with some corresponding benefit (such as increased financial aid for college students)? seq NL1 \r 0 \h Theme B: The Budget Process seq NL1 \r 0 \h Instructor ResourcesJasmine Farrier. Passing the Buck: Congress, the Budget, and Deficits. Lexington: University Press of Kentucky, 2004.James J. Gosling. Budgetary Politics in American Governments. 3rd ed. New York: Routledge, 2002.Dennis S. Ippolito. Why Budgets Matter: Budget Policy and American Politics. University Park: Pennsylvania State University Press, 2003.Lance T. LeLoup. Parties, Rules, and the Evolution of Congressional Budgeting. Columbus: Ohio State University Press, 2005.Irene S. Rubin. The Politics of Public Budgeting: Getting and Spending, Borrowing and Balancing. 5th ed. Washington, D.C.: CQ Press, 2006.Allen Schick and Felix LoStracco. The Federal Budget: Politics, Policy, Process. Revised ed. Washington, D.C.: Brookings Institution Press, 2000. Aaron B. Wildavsky and Naomi Caiden. The New Politics of the Budgetary Process. 5th ed. New York: Pearson/Longman, 2004. seq NL1 \r 0 \h SummaryThe budgetary process inevitably involves choices about which specific areas should be funded and which ones should be cut, about who stands to benefit from the shape of the budget and who will pay for the programs. Client politics cannot be ignored, so budgetary policy must be constructed through the collective (and frequently opposing) viewpoints of a number of federal institutions and individuals.In the executive branch, the troika consists of: SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .The Council of Economic Advisers (CEA), which generally represents the promarket views of professional economists. Presidents do, however, appoint ideologically sympathetic economists.2 seq NL_a \r 0 \h .The Office of Management and Budget (OMB), which is responsible for preparing a federal budget in accordance with the president’s program. It tries to be both a nonpartisan analyst of spending and budget patterns and an activist imposing the president’s wishes on the bureaucracy.3 seq NL_a \r 0 \h .The Secretary of the Treasury, who is generally expected to represent the finance community’s point of view.The Federal Reserve System, which regulates the nation’s money supply and interest rates, is theoretically independent of both the president and Congress, because its members serve fourteen-year terms. However, because the president appoints members, he does have some influence over the Fed.Congress is instrumental to the budget process because it must approve all taxes and almost all expenditures. To centralize the budget process, Congress passed a budget law in 1974 that requires budget committees in each house to produce a budget resolution that, when adopted, imposes ceilings on overall spending and on spending in each area (such as health and defense). These ceilings are supposed to guide legislative committees in drawing up specific appropriations bills. President Reagan used the process in 1981 to get Congress to vote about $36 billion in spending cuts for fiscal 1982. For his strategy to work, it was necessary to get Congress to vote for a total package of cuts before it voted on any individual cut.Cutting spending is necessarily a difficult matter. About three-fourths of all federal outlays are relatively uncontrollable, because they are tied to entitlement benefits (many of these will be discussed in the next chapter). Congress could reduce entitlement benefits in order to boost discretionary spending, but it would be politically risky.Cutting taxes, by contrast, would seem to be politically very popular. However, people object less to income taxes, which are withheld from paychecks and never seen, than to local property taxes. Further, Americans are more concerned about balancing the budget than about cutting taxes. In the past, tax cuts exacerbated the chronic series of deficits that the federal government ran over the last quarter of the 20th century. Consequently, when Reagan attempted to implement his supply-side economic theory in 1981, he found it quite difficult to round up the votes in Congress. He was able to do so only by adding a large number of “sweeteners” for special-interest groups to his basic three-year, 27 percent, across-the-board cut. Over the long run, the most important provision of this tax bill was the indexing of tax brackets, beginning in 1985. This was intended to eliminate automatic de facto tax increases caused by bracket creep and to force Congress to explicitly raise taxes if it wished to generate more revenue. George H. W. Bush and Clinton also proposed tax increases, and their bills passed with very narrow majorities. In 1997, though, taxes were cut as part of a legislative-executive compromise intended to balance the budget.Generally, however, the George H. W. Bush and Clinton administrations combined tax increases and spending cuts to lower the deficit. In particular, the Budget Enforcement Act of 1990 imposed a cap on discretionary (nonentitlement) spending: money could be moved from one discretionary area to another, but any additional spending would require increasing taxes. The tax increase and the 1990 act had some effect in cutting the deficit, but most of the budget surplus in Clinton’s second term was the product of Social Security taxes.In 2001, the George W. Bush administration negotiated to secure passage of the Economic Growth and Tax Relief Reconciliation, which is one of only three large tax cuts passed after World War II. Democrats opposed this bill, because they wanted to use the budget surplus to finance government programs, rather than to provide tax cuts. They did succeed in their efforts, in that the legislation provides tax cuts only until 2010; they also secured increased levels of funding for many federal programs. Following the terrorist attacks of 9/11, however, the issue of a budget surplus seemed moot. Increased spending for the war on terrorism and for homeland security decreased the likelihood of a budget surplus. seq NL1 \r 0 \h Discussion Questions SEQ NL1 \r 0 \h 1 seq NL_a \r 0 \h .What tools does the president have to manage the economy? Are they sufficient to do the job?2 seq NL_a \r 0 \h .Compare the national budget with your personal budget. What are the problems with having most of your budget determined in advance by fixed expenses? For example, when housing, transportation, and food expenses consume most of your budget, what will happen if there is a crisis of some sort? What does the government have to do when it encounters a crisis, such as the 9/11 terrorist attacks?3 seq NL_a \r 0 \h .Part of the difficulty in determining the budget is estimating how much revenue will be received. How many different taxes does the government impose to generate revenue (for instance, income tax, excise taxes, telecommunications tax, and so forth)? Would it help with budget planning if the government had just one large revenue source instead of multiple taxes? Would it be economically or politically feasible for the government to collapse all of its revenue into a single tax? Why or why not? 4 seq NL_a \r 0 \h .To what extent does the public have a say in the budget process? Does public opinion significantly affect the types of budgetary decisions that are made by government leaders? How do pork-barrel projects and the practice of earmarking affect the overall budget? ................
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