A.P. Civics Notes: Chapter 16
“Economic Policy”

1. Economic Health
1. During the 1980s, people who were supposed to hate deficits voted to create more, and those who wanted tax loopholes voted to close them, but in the 1990s, tax increased (like normal).
1. Most of these actions, however strange, were caused by public opinion.
2. Economic realities like the general health of the nation, the level and distribution of taxes, and the amount and kind of gov’t spending heavily influence economic policy, or how the gov’t wants to work the American economy and pay for its spending.
3. The public generally cares about what happens to it, individually, but it also cares about collective results as well, and thus forces politicians to meet both ends.
1. Economic conditions often influence the success of incumbents, and voters are often worried about their own pocketbooks, voting Democratic if they’re worried about unemployment and Republican if they’re concerned about inflation and voting against the incumbent if they’re own families’ finances had gotten worse and vice versa.
2. On the other hand, voters sometimes vote against incumbents if general finances have gone down, or if the economy has worsened.
3. In both the U.S. and Europe, voters nevertheless seem to respond more to the condition of the national economy than to their own personal finances because they feel that the national economy is inter-connected, and what happens to other people could happen to them.
4. Since the 19th century, the American gov’t has used money to affect elections, whether by giving money to faithful patrons or by increasing Social Security benefits every election year.
1. The gov’t often cannot reduce employment, cut inflation, lower interest rates, and increase incomes just to win elections because it does not know how to do one w/o ruining the other.
2. Politicians must make careful, long-term choices about economic policy, since it is very hard to stimulate the economy with a snap.
1. While all politicians like to have the best economic conditions, reality makes them choose which problems to tackle first (i.e. Democrats go after unemployment first).
3. Basically, most Democrats are more worried about unemployment than Republicans, while Republicans tend (though not as much) to worry about inflation.

Economic Theories and Political Needs

Policies aimed at improving the economy as a whole are examples of majoritarian politics.

A healthy economy benefits almost everyone while a stagnant one helps no one, but presidents and economic policy deciders must take responsibility for whatever results that occur, since the economy is unpredictable and quite complex.

1. There are four major theories on how to best manage the economy:
1. Monetarism suggests that a gov’t should have a steady, predictable increase in the money supply at a rate about equal to the growth in the economy’s productivity, and beyond that, free market enterprise should operate.
2. John Maynard Keynes, the economist who introduced Keynesianism, the gov’t must create the right balance of demand and supply, and when demand is too low, the gov’t should pump more money into the economy (spend!) and vice versa.
3. Economic planning is liked by economists who have too little faith in a pure free market enterprise to be Keynesians or monetarists, so they suggest price and wage controls (advocated by John Kenneth Galbraith, et. al.) to control stuff during inflationary times (so there’s no upward spiral) and adopt an industrial policy where the gov’t helps invest in basic industries so that they can survive bad times.
4. Supply-Side Tax Cuts says that the gov’t should interfere in the economy less, and tax reductions will increase the incentive to work, making total tax income higher while total tax rates lower.
2. Conservatives generally like monetarism and supply-side tax cuts while liberals stick to Keynesian politics and socialists like economic planning; this is all due to people’s personal preferences.
3. During Ronald Reagan’s term, a new policy nicknamed “Reaganomics” arose, combining monetarism, supply-side tax cuts, and domestic budget cutting in an effort to simultaneously reduce the size of the federal gov’t, stimulate economic growth, and increase U.S. military strength.
1. Domestic spending plunged, military spending soared, personal income taxes were cut, and Social Security taxes were upped.
2. Huge deficits were created, but the reason was that people, with more money in their pockets, would spend more, stimulate the economy, and thus help pay for the deficit.

The Machinery of Economic Policy Making

1. In the executive branch, there are three other important people in economic affairs: the chairman of the Council of Economic Advisors (CEA), the director of the Office of Management and Budget (OMB), and the secretary of the treasury.
2. The CEA is supposed to be a group of impartial experts who forecast the economy.
3. The OMB was originally the Bureau of the Budget, and it prepares estimates of the amount of spending that gov’t agencies will partake in and also (lately) analyzes budget and spending patterns.
4. The secretary of the treasury is often drawn from or close to the world of business and finance and is expected to argue the point of view of the financial community; he estimates revenue from existing tax laws and represents the U.S. in its economic dealings with other nations.
1. Obviously, there is a lot of pulling and shoving and compromise among these three.
2. There are also way too many bureaus formulating economic policy, and that creates chaos.
5. The seven members of the board of governors of the Federal Reserve System (the “Fed”) are chosen by the president for 14-year, non-renewable terms, and the Fed regulates the supply of money in the country, changing interest rates charged to banks, and buys and sells federal gov’t securities.
1. The Fed is usually pretty independent, but a determined president can change economic policy if he really wants to.
6. Congress is the one that approves all taxes and almost all expenditures (price & wage controls, etc…), thus making it very powerful, but it’s also fragmented, influenced by key committees.
1. Thus, no matter what economic policy a president has, he must put it through the many agencies within the executive branch, the independent agencies like the Fed, and various committees of Congress.
7. Most economic tendencies affect people equally, but if most people are doing well and a few people are suffering, such as the case was during the 1980s (steel and farming industries suffered), there can be a problem, and parts of the nation can be split against each other.

Spending Money

1. The gov’t must also adhere to the demands of special interest groups, not just improve the economic health of the nation with majoritarian politics, and such a case creates client and interest group politics.
2. Most people think that gov’t overspending is the cause of a deficit, but they also want more money spent on education, homelessness combating, childcare, crime control, and many other things.
3. Thus politicians have incentive to cut gov’t spending AND give money to certain programs.

The Budget

1. A budget is a document that details how much the gov’t will collect in taxes and spend in revenues and how these expenditures will be allocated to certain programs.
1. Supposedly, it decides how much money there is and THEN where it will be spent on.
2. In reality, it’s more of a list of everything that the gov’t will spend, w/o regard to how much money is actually available.
2. Before the Congressional Budget Act of 1974, there was no established budget, and even those that were formed were sometimes ignored, but afterwards, the president submitted a budget in January, where two budget committees in the House and the Senate debated and then passed its own budget resolution that would be adopted in May, but a second one could be made in September.
1. However, there is nothing to prevent Congress from ignoring its May resolution and just using its September one.
2. Nevertheless, Congress is now more conscious about what it spends and how it does that.
3. During the Reagan years, the May budget didn’t simply set a spending ceiling, it was used to make cuts in programs!
4. The procedures used by Congress affected policies that it adopted here.
5. In theory, if Congress voted on spending before the “public did,” it would go down, but this didn’t turn into reality that much after 1981, and the deficit eventually grew so much that even politicians eager to satisfy constituent demands worried about national economic health.
6. Eventually, the Gramm-Rudman Balanced Budget Act called for lowering the deficits each year from 1991 to 1996, and if that didn’t happen, a sequester would occur in which across-the-board cuts would occur in all programs, except exempt programs.
3. In 1988, George Bush said, “Read my lips, no new taxes,” but by 1990, only a tax increase would counter a sequester of close to $100 million, and new taxes were introduced; this was aimed to get the Republican White House to 1992 w/o immediate tax cuts, but it did nothing to cut the deficit.
4. In 1993, the Bill Clinton budget claimed to eliminate the deficit over five years!
1. The top tax rate would go from 31% to 39%; 85% of Social Security benefits would be subject to taxation, up from 50%; $56 billion in spending cuts would come from Medicare; federal gasoline tax goes up from 14.1 cents to 18.4 cents.
2. After the fall of the Soviet Union, there were talks of a peace dividend, where defense spending would be cut since it was no longer needed (no more Cold War).
3. Clinton eventual made compromises to get the bill passed, and many Republicans argued that there were too much taxes and too little spending cuts.
5. In 1997, Clinton agreed to cut some spending if Republicans cut some taxes.
6. Cutting spending is hard, because many “uncontrolled” expenditures involve signed contracts.
7. It’s almost impossible for any president to know how by much he has cut the budget, since unexpected events can mess up previous estimates.

Levying Taxes

1. Tax policy reflects a mix of majoritarian and client politics; in the U.S., a “fair” tax law has generally been viewed as one that keeps the overall tax burden rather low, makes everyone pay something, but makes the richer pay more.
1. The tax burden in the U.S. is lower than it is in most democratic nations.
2. In 1986, a sweeping tax reform act closed many loopholes that people could previously use to pay less income tax (btw, a sales tax is much harder to evade).
2. In 1913, the 16th Amendment was passed, authorizing a graduated income tax (richer people paid more; poorer people paid less), and for the next 40 years or so, rates tended to go up during wartime and down during peacetime (the top percentage, or marginal rate—how much the richest paid—went up to 94% during World War II!!!).
1. One might think that the rich were REALLY hurt by this, but deductions, exemptions, and exclusions helped the rich preserve a LOT of their money.
2. The eventual compromise during the first half of the 20th century was that Democrats (supported by the poor) would support loopholes if Republicans (representing the rich) would support high marginal rates.
3. During debate over the 1986 tax reform bill, interest groups tended to cluster around certain loopholes, like certain deductions or subsidies; what resulted was low rates and smaller deductions, resulting in a loss for businesses.
3. Majoritarian politics had resurfaced in the form of a cry for fairness, and policy entrepreneurs were able to point to real and imagined scandals to get change.
1. Some professional economists had complained for years over the faults of the old tax code and that high rates discouraged investment.
2. Another kind of entrepreneur, led by Jack Kemp, liked supply-side economics.
3. Others were journalists and publicists who liked to report on “tax cheats” that were legal but rather unfair in the eyes of public opinion.
4. These entrepreneurs obviously greatly influenced important politicians to get what they wanted, and they did, and clients groups who acted unprofessionally in fighting to keep loopholes also helped provoke final reform, and when the 1986 bill was passed, tax politics had come full circle, from a product of majoritarian politics to a caterer of client politics back to majoritarian politics.
1. However, afterwards, more tax deductions were added, rates were increased, and people began complaining that the tax law had become so complex that the average person could no longer figure out his or her own taxes!