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Please be aware that this is a student-generated wiki designed for review for my students' AP exams. Come in, look around, and enjoy yourself...just be aware of the nature of this wiki. Even though most everything is correct, I advise caution before citing this as an authoritative source.

Economic Policy

Since economic policy affects the American public both individually and as a whole, it is of primary concern towards politicians. Yet there are so many contributing factors to what makes an economy "stable" - it is up to politicians to decide what moves to make regarding the economy are correct.

Economic policy aims to improve the national economic health via government spending and taxation policies.
Most Americans do not think it is a good idea for the government to spend more money each year than it takes in from taxes--nor are they willing to pay more taxes to offset this deficit--but the government still does not have a balanced budget (or even try to).
  • The federal government never has to declare bankruptcy because, when it needs more money, it borrows it by selling bonds (Wilson)
On the other side of the coin, the government can contract a potentially dangerous rapidly-growing money supply by selling bonds. Either way, the government is structured top be able to expand and contract the economy through the money supply in case of high inflation or unemployment.
  • In a typical year, interest payments are the third biggest item in the national budget, right after money spent on income redistribution and national defense (Wilson)
  • As of 2014, the US' national debt is about 96.1% of our annual GDP
The Economic Growth and Tax Relief Reconciliation Act of 2001 occurred because the American economy had grown so rapidly which flooded Washington with money. This money was used to create new programs and cut taxes for people.(Wilson 493)

Economic Growth and Tax Relief Reconciliation Act of 2001- over a ten-year period did the following:
  • decrease tax rates for each income bracket
    • The tax rates would fall as follows: from 28% to 25%, from 31% to 28%, from 36% to 33%, and from 39.5% to 35%.
    • New 10% bracket created.
  • increase tax credit for children
  • decrease effort needed to deduct expenses
  • remove the marriage penalty
  • decrease effort needed to save for education
  • slowly remove the tax on estates of deceased people
*In 2004, three of these tax cuts were made permanent: the cut in the tax rate on U.S. citizens with the lowest earnings, ending the marriage penalty, and increasing the tax credit for children. The marriage penalty had made it possible for a married couple to pay more in taxes than they would have if they had remained single.
  • However, we can not predict what effects tax cuts will have on the future. Not even the OMB or CBO can estimate it.

The public wants less total federal spending but more money spent on specific federal programs and a deficit ensues.
Deficit-when a government spends more money than it receives from taxes
  • Republicans enacted one of the three largest budget cuts in 2001 (Wilson)
  • This is different from debt as debt is the collection of all past deficits and surpluses. If the government were taking in more money in taxes than were being spent, it would not necessarily mean that the government was debt free.

What Politicians Try to Do
  • Elected officials take a short-run view, as well as policies that will best interest "self-regarding voters" currently and not policies that will be long term
    • Oftentimes, politicians that are elected look at the short-term results, because they want policies that will quickly change the lives of the voters in order to increase their chances of reelection (Wilson).
  • Democrats and Republican alike would prefer to have both low unemployment and no inflation. (Wilson 496)
    • As much as people may say something along the lines of "Republicans hate jobs!", both sides want high employment and no inflation, they just have different methods
  • Scholars believe politicians just want to lower unemployment rates and raise family incomes before an election (in order to win).
    • There is no clear evidence of this. Another reason is that government does not know how to produce all these desirable outcomes.
    • Doing one thing may result in the cost of not doing another.
      • For example an attempt to reduce inflation will cause them to increase taxes
      • An increase in inflation also correlates to an decrease in unemployment, furthering the belief of scholars that politicians want to lessen unemployment before elections.
  • When politicians do try to do something the Democrats mainly attempt to reduce unemployment and Republicans try to reduce inflation
    • But both sides want low unemployment and low inflation, they just have different priorities
    • The tension between politicians usually results in no action taken
  • A politicians choices for the economy are faced with uncertainty and ignorance.
  • During the 19th century, government used money to affect with elections and to get more votes. Patronage was used a lot back then to acquire votes.
National Debt- total deficit from the first presidency to the present minus all the surpluses.
  • The federal government never has to declare bankruptcy because whenever it need more money. It has the Federal Reserve sell bonds on the open market to the foreign and domestic markets to fund its spending.
  • As required by the government these bonds are always repaid.
  • However, Washington must pay interest in this debt, every year.
  • In a typical year interest payments are the third biggest item in the national budget, Right after money spent on income redistribution and national defense.
  • Almost every American has a debt.
  • There is personal debt and debt owed to the federal government. Government loans are a type of debt.
  • To see or understand what our national debt really is you have to do what the head of every household does: compare how much you owe with how much you earn.
  • Most people tend to use deficit and debt interchangeably but the difference is one is for a given year and one is a cumulative total for past decades.
  • The national debt is always increasing because unlike a normal person the federal government does not just declare bankruptcy. Instead they sell bonds. These bonds then later have to be repaid with interest. Interest is the third highest expenditure for the United States government (behind redistribution and national defense)
  • Not all the national debt is owed to other countries or expenses. Much of the debt is owed to Americans and the American government domestically.
Gross National Product (GNP)- Defined by the Census Bureau as the "total output of goods and services produced by labor and property of the United States. Valued at market prices"
  • voters see connections between their personal economic condition and that of the nation as a whole (Wilson).
  • Congressional candidates can easily evade the responsibility for economic conditions and can blame it upon the President (Wilson).
  • GNP is not used as the more reliable measure of a nation's prosperity and output, as GDP is more reliable for what it looks at and takes into account.
Gross Domestic Product (GDP)-The key economic measure of analyzing economic trends. It is the monetary value of all the goods and services produced within the nation in organized markets for a given year.
  • When there is a surplus in the national budget, a new debate begins. One group, primarily Republicans, want to give the surplus back to the people by cutting taxes. Another group, primarily Democrats, wanted to use the surplus for new programs. Both of these goals were served in the Economic Growth and Tax Relief Reconciliation Act of 2001 which President George W. Bush proposed and Congress passed. (Wilson)
  • We could get rid of our annual deficit and make progress toward reducing our total national debt if we did at least one of two things: raise taxes or cut spending.
    • In general, political conservatives want to cut spending and political liberals want to raise taxes.
Economic growth is a result of capital deepening, increased investment in capital stock, increased investment in human capital, increases in quantity of human resources, new technology leading to increased productivity, increase in quantity and quality of natural resources.

Depression: a severe downturn in the economy
Monetarism- the belief that inflation occurs when there is too much money in circulation
Recession: is when GDP slows, businesses stop expanding, unemployment rises, and housing prices fall.

GDP, although a great indicator of a countries economic prowess, should not be used to extrapolate on a nation's real economic health, as GDP does not take into account intangible extraneous factors that can be significant in the economy.

  • belief that government should not become involved in economic issues
    • The Constitution gave congress the power to regulate commerce among the states.
  • supported by the "rugged individualists" of the 1800's
  • deregulation can be seen as a type of laissez-faire, since it is the government's lack of rule over policy
  • Concept challenged in the late 19th and early 20th centuries with "trust-busting" legislation.
  • belief that the narrow pursuit of individual profit serves the broadest interest of the people
  • after the Great Depression in the 1930's, this was not an appropriate government option anymore
    • The public thought that the government should intervene in the economy and lessen the financial burden.
    • The government's, mainly Congress', role in the economy has expanded to the point that interstate commerce deals with intrastate commerce.
  • created by Adam Smith in The Wealth of Nations
    • Related to "laissez faire," or a hands-off mentality when regarding the government and free trade markets.
  • Also known as Free trade
  • The opposite of Protectionism and mercantilism


  • Keynesianism is the belief the government must manage the economy by spending more money when in a recession and cutting spending when there is inflation.
    • the key is to create the right amount of demand so the government should pump more money into the economy or take money out depending on the economy
    • Keynesian economics was created based on the theories of British economist John Maynard Keynes
    • Keynesians tend to favor an activist government and are not too concerned with a balanced budget but instead with the performance of the economy (Wilson).

The Politics of Economic Prosperity
  • To some extent, people consider their own financial situations when voting.
    • Low-income people who would be harmed more by unemployment are more likely to vote Democrat. So democrats aim at reducing unemployment.
    • High-income people who would be harmed more by inflation are more likely to vote Republican. And republicans aim at reducing inflation.
  • Health of American economy creates majoritarian politics, because most people want the same thing. Which is to have low unemployment, low inflation/ interest rates and greater government programs.
  • However, for the most part, people vote based on the condition of the national economy, not their own pocketbooks.
    • an example being that if the unemployment level is at 10%, the majority of the nation isn't really effected by the unemployment level, but they still vote to try and lower the level of unemployment.
    • With this in mind politicians will generally adopt policies with a short term view which will satisfy the voter and get them votes, rather than thinking ahead.
  • According to Wilson, voting behavior and economic conditions are strongly correlated at the national level but not at the individual level, and this is true in both the United States and Europe. Such voters are behaving in a "sociotropic" way.This is because voters look and see how their neighbor, family and friends are doing. They are not only considered with the effects of the economy on themselves but the people they know as well.
    • According to Wilson, there are two explanations as to why this is: people understand what government can and cannot be held accountable for; and people see general economic conditions as having indirect effects on them even when they are well off (Wilson and Dilulio 495).
  • Younger voters, whose incomes tend to go up each year, often worry less about inflation then do retired people living on fixed incomes, the purchasing power of which goes down with inflation. (Wilson)
  • The federal government uses money to try and buy votes, but this does not necessarily mean that they are interested in actually doing the promises they make such as reducing unemployment, lowering inflation, lowering interest rates, or raising income (Wilson 495).
  • Presidents try to stimulate the economy before an election, but if that doesn't happen they can lose due to economic issues
    • Ex: Ford losing in 1976, Carter in 1980, George H.W. Bush in 1992

In 1981 Pres. Ronald Reagan set in motion Reaganomics, a combo of domestic budget cuts, monetarism and supply-side tax cuts.
-Definition: the belief that a combination of monetarism, lower federal spending, and supply-side economics will stimulate the economy
-Lowering taxes and increasing spending was meant to stimulate the economy, all the while creating very large deficits. Since the deficit increased greatly, the national debt also increased largely. Decrease in taxes was meant to increase investment which would also stimulate the economy (Wilson and Dilulio).
-The four pillars of Reagan's economic policy included:
  • To reduce growth of government spending
  • To reduce federal income tax and capital gains tax
  • to reduce government regulation
  • to control money supply to reduce inflation
As with most presidents, President Reagan's economic goals were not very consistent. Inconsistencies in Reaganomics were the result of trying to combine concerns about inflation, economic freedom, unemployment, and increased military spending.
Reagan sought to achieve several goals:
  • Reduce the size of government
  • Deregulation of several important industries, including airlines and telephone companies.
  • A cut in personal income tax
  • Cut in inflation but allowed interest rates to rise.
  • Increase in military spending
In the end, defense spending had increased and left a large debt, while unemployment and inflation had lessened. However, federal taxes jumped.

- Monetarism: developed by Milton Friedman, is an economic theory that states that inflation occurs when there is too much money and too little goods. Monetarists believe that the government's job is to do a predictable steady increase in the money supply at the rate of economic growth and productivity, and then allowing the free market to carry out naturally from there.
  • When an inflation occurs, government often tries to cut back sharply on the amount of money in circulation, creating a recession with a slowed economic growth and an increase in unemployment The government will then have an unbalanced budget and create new welfare programs. That is why monetarists believe the government should stick to creating a steady money supply and leave the rest alone.
  • The Theory answers concerns regarding inflation that libertarian, conservatives, and Republicans have.

Reaganomics Effects:
*Stimulated economy.
*Government spending inc. but slowed.
*Interest rates rose but inflation was cut.
*Rate of growth of spending slowed but, did not decrease spending itself
*Military spending increased
*Money supply controlled
*Federal taxes decreased although taxes significantly decreased, the amount of things that you could write off on your taxes was also decreased, this gave the impression that taxes were cut by more than they really were.
*Large deficits incurred and dramatically increase the size of the national debt
*Unemployment decreased
*Business Productivity Increased
*Spending on domestic and social welfare programs were reduced

Supply-Side Theory
- Need less government involvement.
-The belief that lower taxes and fewer regulations will stimulate the economy
-Supporters of this system believe there should be less government interference for greater productivity.
-Arthur Laffer and Paul Craig Roberts are famous supply-sider economists that held the belief that the economy was never given a fair enough chance to improve on it's own. (Wilson pg 498)
-Cutting taxes will increase people's incentive to work, save, and invest (Wilson)
-A reduced tax would discourage people from using loopholes and encourage people to spend more because greater investments lead to more jobs which are taxed less so people will have more money to spend (Wilson 498).
-The increased productivity from the reduced tax would also benefit the government because the greater prosperity would raise tax revenue
-Even though tax rates will be lower, the total national income to which the rates are applied will be higher.
- Though, this theory supports the political beliefs of libertarians and conservatives, it does not take into consideration the possibility and effect of inflation and unemployment, according to Benson and Waples.
-Like Monetarists, they believe that inflation is caused by too much money chasing too few goods

The Two Economic Theories
- Monetarism: Monetarism was brought about by Milton Friedman. The belief that inflation occurs when too much money is chasing too few goods.
  • In other words, monetarists believe inflation occurs when the federal government prints too much money.
  • The Federal Reserve Board can manipulate the money supply in three ways: changing the reserve requirement(the amount that banks are required to keep), changing the discount rate(the interest rate that banks pay to the Fed), or buying or selling government bonds
  • Rate reductions make borrowing money less expensive because interest on the money is low, leading to economic inflation, resulting in higher prices and wages.
  • they have this opinion because they believe inflation and recessions occur based upon the government’s blind mistake of having a “start-and-stop” habit of issuing new money.
  • they believe that if government were to increase its spending, this would crowd out private investment and spending, thus having little to no effect on the economy
- Keynesianism: Keynesianism is based on the work of the English economist John Maynard Keynes who thought that the government must manage the economy by spending more money when in a recession and cutting spending when there is inflation.
  • Keynes believed that is important to create the right level of demand, which is a task of the government, who should pump money in and out of the economy in order to keep it stabilized.
  • A fundamental belief of Keynesian economists is that "in the long run, we are all dead" and with this belief they believe that governments need to take active policy measures to ensure short run economic stability instead of letting the economy 'self-correct'
  • This theory states that the economies health depends on people and how they save or spend their income.
  • Keynesianism believes that the government should take money out of the economy by increasing taxes or cutting expenditures, when the demand is too high. If demand becomes too low then the opposite is suggested, the government should then begin to pump more money into the economy via spending more than it takes in or through public works projects (Wilson 497).
  • This economic theory tends to favor an activist government that has more influence over the nation's economy and market.
  • According to Benson and Waples this theory answers the liberal concern with unemployment.
  • Some doubts about about Keynesianism arose when Stagflation (high inflation and high unemployment) became an issue in the 70's

Economic Planning
- Some believe that the free market is too unreliable and should be interrupted by government activity to ensure that economic activity remains healthy.
- John Kenneth Galbraith believed in wage and price controls to deal with inflation, for example.
-In his view, big corporations can raise prices because the forces of competition are too weak to restrain them, and labor unions can force up wages because management can easily pass the increased cost to consumers as higher prices.
-Economic planning is seen the US in areas such national defense and education
-Some economists attempt to forecast the health of the economy, but projections about the economy are usually not accurate, this can be due to the random or unforeseen disasters that would hurt the economy
- It is believed by some that the United States government should direct investments to certain industries that may falter or fall to the wayside. However, this is not a popular belief in the US, according to Benson and Waples, but is much more acceptable in Europe, Asia, and Africa.
-After the mid-1980s, a different form of economic planning was called to attention. Referred to as an industrial policy, it reflected the public's concern for declining health of certain basic industries such as steel and automobile manufacturing. According to Wilson, advocates of this type of planning often point to Japan as an example of a country in which the government directs industrial investments.
  • Price and Wage Controls
    • Big corporations can raise prices because the forces of competition are too weak to restrain them, and labor unions can force up wages because management finds it easy to pass the increases along to consumers in the form of higher prices.
      • Therefore, the government should react to inflation by regulating the maximum prices that can be charged and wages that can be paid.

The Budget
  • Federal Budget: states the amount of money the government expects to receive through taxes; authorizes government spending for the fiscal year (5 Steps to a 5). Each budget covers one fiscal year and is named after the year in which it ends.
    • The federal budget can be balanced every year, meaning that there is neither a surplus or a deficit. This is the point where the money spent by the government is equal to the revenues.
      • Annually balanced budget: The government can make sure that there is no presence of either surplus or revenues at the end of each fiscal year, in order to achieve such a policy. This view is advocated by those that oppose the large deficits of the U.S. government.
      • Cyclically balanced budget: The government can try to counter deficits incurred during recessions with the surpluses during the "recovery and peak" portion of the business cycle.
  • Fiscal Year: For the federal government, October 1 through the following September 30.
  • In theory the federal government would find out how much money was available to be spent and then allocate that money to the various programs and agencies.
  • Instead, the federal government chooses what money is going to be spent on and then decides later how much is needed to do this, this where the national debt comes in.
  • Budget Resolution: A congressional decision that states the maximum amount of money the government should spend.
  • Entitlements: A claim for government funds that cannot be changed without violating the rights of the claimant. Examples of these include Social Security and Medicare payments, veterans' benefits, food stamps and money the government owes investors who have bought Treasury bonds.
  • Government can only change only about one-third of federal spending in any given year (Wilson and Dilulio 503).
  • Congress is expected to adopt these resolutions in order to guide its budget debates
    • Considers appropriations bills (bills that actually fund programs within established limits) and sees whether they are congruent with the budget resolution. (Benson and Waples).
  • The president submits the budget.
  • The House and Senate budget committees study the budget after receiving an analysis from the Congressional Budget Office.
  • In theory the federal budget should be based on first deciding how much money the government is going to spend and then allocating that money among different programs and agencies.
  • Instead of being a way to allocate money to be spent on various purposes, it is a way of adding up what is being spent.
  • There is also a big loophole in the current budget process: nothing requires Congress to tighten the government's financial belt.
    • The theory behind closing the loophole is to require Congress to vote on a budget ceiling for each fiscal year. This will allow a decrease on total spending. (WIlson 504)

Reducing Spending
  • In 1974 the Congressional Budget Act was made to lead to reduce spending but it didn't work.
  • Procedures:
    • The budget is submitted by the president.
    • Each congressional budget committee proposes a budget resolution that sets a budget and spending ceilings. Congress is expected to adopt these resolutions as a guiding factor for its budget debates (Fast Track to a 5).
    • It is important to note that although the president submits a budget, Congress has no limitation in the amount of changes they can make to it once they receive an analysis from the Congressional Budget Office (CBO). They can pass a resolution that is more or less than what the president suggests (Wilson 504).
  • Gramm-Rudman Balanced Budget Act (1985) which called for a target cap on the deficit of each year to lead to a balanced budget. IF there was no agreement there would have been automatic across-the-board spending cuts.
  • "Smoke and mirrors" and failure of the Act: the plan was unpopular but was "necessary". The President and Congress got ways to increase spending on what they wanted anyway.
  • Other New Strategies: Congress voting to increase tax, and the Budget Enforcement Act of 1990 that imposed a cap on discretionary spending (ex: non-entitlements), and there is no limit settled on mandatory spending however there is a "pay as you go" approach.

Levying taxes
  • taxes are usually lower in america than any other nation.

Policy Making
  • Policy making is fragmented; the president does not have full control
  • Three people besides the President are of special importance in economic policy making: the Secretary of the Treasury, the chairman of the Council of Economic Advisors, and the director of the Office of Management and Budget. Known as the Troika, these three people represent the head honchos of economic policy residing in the Executive branch in addition to the President himself.
  • During the early 90's when our economy had an surplus their was an argument over how to spend it some wanted it on programs others wanted it on defense. There was also a possibility that within a few decades of surplus, the national debt would be paid off (obviously, this did not happen).
    • Congress
      • The most important part of the economic policy making machinery (according to Wilson)
      • Specifically the House and Senate Budget Committees, the House Ways and Means Committee (deals with the taxing aspects of the budget), and the Senate Finance Committee (according to Wilson.), Authorization committees in both houses (decide what programs Congress wants to fund), the House and Senate Appropriation Committees (decide how much money to spend for those programs that have been authorized).

    • Council of Economic Advisers (CEA): professional economists sympathetic to the president's view of economics,
      • Other duties include preparing the annual economic report sent to Congress by the president and the forecast of economic trends and analyzing issues.
      • The CEA is a part of the Executive Office.
    • Congressional Budget Office (CBO): try and estimate what the economy will look like in the future. Sadly they are often wrong.
    • Office of Management and Budget (OMB):prepares estimates of the amount of money that will be spent by federal agencies, negotiates with other departments over the size of their budgets, and makes certain that the legislative proposals of these departments are in accord with the president's program (as best as it can). (Wilson and Dilulio).
      • part of the white house
      • Ensures that the legislative proposals are compatible with the Presidents ideologies which the President submits to Congress.
      • The OMB and CBO are often incorrect at making accurate predictions of the economy.
        • For the years 1993 through 1997, for example, the CBO and OMB released reports stating that there would be a larger deficit than here actually turned out to be.
        • Additionally, in 1999 the CBO that budget surpluses would accumulate to over $2.9 trillion in the next decade. They based this on the significant economic growth occurring then, but as early as 2002 there was a budget deficit of $121 billion. This in part had to do with 9/11. There was also a recession. Tax reductions had also recently been passed recently by Congress through influence by the Bush administration. This also played a role in the larger deficits. [1]
    • Secretary of the Treasury (from the study guide) :
      • provides estimates of government's revenues
      • expected to argue the point of view of the financial community
      • recommend tax changes
      • represents the nation before bankers and other nations
      • is a member of the president's cabinet and is often close to or selected from the business and finance world
    • The Federal Reserve Board (The Fed):Regulates the supply of money and the price of money
      • Consists of seven members, appointed by the president with the consent of Senate, for fourteen-years, nonrenewable terms, and may not be removed except for cause
      • One chairman--serves for four years
      • The Fed is, in theory, independent of both the president and Congress but in practice, the different groups can indirectly influence each other.
      • Aims to ensure the "safety" of banks by requiring a reserve ratio and lending fellow banks loans when they are needed
      • Buys and sells government securities to increase/decrease the money supply (and stimulate/discourage spending)
- In theory, it is independent of both the president and Congress
- It sets monetary policy (managing the economy by altering the supply of money and interest rates)
  • These agencies report to the country economic statistics such as the:
    • Unemployment rate
    • Consumer Price Index (CPI): A measure of the average change in price over time in a fixed "market basket" of goods and services. (U.S. Census Bureau)
      • The CPI can be used to see changes in costs-of-living and therefore shed insight on inflation.
      • Other indices are available for other "market baskets", such as the Producer's Price Index (PPI) and the Import Price Index.
    • Gross National Product (GNP): The total output of goods and services produced by labor and property of the US. (Census Bureau)
      • GNP differs from GDP (below) in that GNP measures the output of all American labour and capital, regardless of location; GDP, on the other hand, measures all production within the borders of the United States, regardless of ownership.
    • Gross Domestic Product (GDP): A measure analyzing the trends of the economy, on a quarterly basis, of the monetary value of all the goods and services produced within the nation and sold on organized markets for a given year. (AP U.S. Government and Politics, Barron's, 2009)
      • GDP serves as a good measure of economic output in the sense that it captures the value of goods and services produced without double-counting either intermediate goods or depreciating capital.
      • However, it does neglect underground market activity (black market, street vendors, etc.) and household production, and may therefore fail to be a perfectly accurate measure of economic welfare.

Congress and Economic Policy-Making
  • Congress has the power to approve all taxes, wage and price controls, and most expenditures
  • It can influence the Federal Reserve Board by threatening to limit the Fed's powers through legislation
  • Congress play a chief role in making fiscal policy, meaning that Congress manages the economy by putting in place certain taxes and various spending laws that must be followed.
  • It is importance that presidents who want to impose a certain economic policy get the support from the committees of Congress
  • Politicians must make careful, long-term decisions about economic policy, since it is very difficult to stimulate the economy in a snap.
  • While all politicians like to have the best economic conditions, reality makes them choose which problems are most important and should be tackled first.
  • Usually the economic health of the nation affects everyone in pretty much the same way-we are all hurt by inflation or helped by stable prices. The incomes of all of us tend to grow or remain stagnant together. When these are the circumstances economic policy is majoritarian politics.

Politics of Taxing and Spending

  • Politicians have to deal with two kinds of majoritarian politics:
1. everyone wants general prosperity
2. large majorities want more government spending on popular programs

  • People want no tax increases, no government deficit, and higher government spending

  • Voters want lower taxes, less debt, and new programs, but the problem is that policies being endorsed are inconsistent with one another
  • Rates do up during wartime and down during peacetime
  • Rates are progressive
  • When taxes need to be raised, politicians manipulate situation to make it seem as if they they’re raising taxes on “other people”
  • The “other people” are the minority of the voters
  • Example: if funding for medical research is needed, then raise taxes on cigarettes
  • Many politicians want to lower everyone’s tax rate because they believe the government doesn’t need all the money it is currently receiving
  • Increasing spending is always more popular than cutting taxes
  • Voters see connections between the nation as a whole and their own situations; for instance, if the national economy is in a recession, many people connect this with their own financial issues.
  • Voting behavior and economic conditions are not always correlated at the national and individual levels. (people don't always vote in line with their pocketbooks.)
  • Congress often finds it difficult to make tax cuts:
  • Politicians get reelected by spending money in their districts
  • Increased spending, (in their districts), is more popular than tax cuts
    • A reason for this could be that the tax cuts across every beneficiary is very small such that some citizens might not even notice, while increasing government spending in a politician's district is visible and beneficial from the perspective of constituents.
  • Politicians have an incentive to make two kinds of appeals:
    • Vote for me and I will keep government spending down and cut the deficit
    • Vote for me and I will make certain that your favorite program gets more money

The Budget: a document that states tax collections, spending levels, and the allocation of spending among purposes.
  • Fiscal year: for the federal government, October 1 through the following September 30.
  • Budget Resolution- A congressional decision that states the maximum amount of money the government should spend.

Council of Economic Advisers (CEA)
  • Members chosen are sympathetic to president's view of economics and are experts
    • Kennedy picked Keynesians
    • Reagan picked supply siders and monetarists
  • According to Wilson other executive agencies see the CEA as the voice of professional economists who tend to rely on the market, as opposed to government control.
  • forecast economic trends
  • prepares annual economic report for president
    • Outlines the economic state of the nation
  • They are composed of three professional economists plus a small staff
  • The CEA has been around since 1946.
  • The CEA is one of the five principle agencies of the executive office, along with the OMB, DNI, OPM, and Office of the U.S. Trade Representative. (Wilson)
  • The CEA is viewed by other executive agencies as the advocate of the opinion of professional economists, who generally tend to favor reliance on the market. (Wilson)

Bureau of the Budget
  • Later referred to as the office of management and budget (OMB) in 1970
  • Largest office under the executive office of the president-500 employed in the OMB
  • Purposes of the OMB:
    • Prepare estimated of the amount that will be spent by the federal agencies
    • To negotiate with other agencies over the size of their budget
    • To make sure that the legislative proposals of these other debts. are in accord with the president's programs
    • As previously mentioned it is hard for any group or member to predict the path of the economy. In 1995 many had thought there would have been deficits and by 1999 it was proved wrong because there was an surplus
    • In preparing the budget, each federal agency has to turn in an estimate of its "needs." The OMB works with the entire staff of the president to combine all of there requests of the agencies and put them into a single budget package. The president turns in this proposed budget to Congress at the beginning of the new year.

Secretary of the Treasury
  • Reflects point of view of financial community
    • "Since its members do not always agrees, this is not always easy" (Wilson and Dilulio).
  • Represents the nation before bankers and other nations
  • Provides estimates of the government's revenues
  • Currency and coinage
  • Recommends tax changes
  • Collecting taxes
  • Advising on domestic and international economic tax policy.
  • Famous Secretary of the Treasury: Alexander Hamilton

Federal Reserve Board
  • How it implements Monetary Policy
    1. Buying and selling of government securities. Government securities include bonds and Treasury notes. In effect, these securities are paper traded for money when the Fed sells bonds to the public or they can be money traded for paper when the Fed buys bonds from the public. This directly affects the amount of money in circulation. An increase in the money supply by buying bonds will reduce the interest rate, which can be adopted as part of an easy money policy. Selling bonds will decrease the money supply, a part of a tight money policy.
      • The Federal Open Market Committee is involved in the purchasing and selling of these government bonds.
      • This committee is composed of 12 people:
        • Board of Governors
        • President at the New York Federal Reserve bank, where most of the open market operations are made
        • Four of the other presidents at the Federal Reserve Banks, who serve for one year at a time
        • This committee discusses how to control the buying and selling of government securities through open market operations, which are used to adjust the money supply. Buying securities will increase the money supply, and selling securities will decrease it.
    2. Regulating the bank reserves. The Fed has the power to raise or lower the reserve requirement of banks, or the percentage of deposits that banks must hold in their reserves. By raising the reserve requirement, the Fed can reduce the amount of excess reserves that the bank can loan out, which will reduce the money supply as part of a tight money policy. Lowering the reserve requirement is part of an easy money policy.
    3. Changing the discount rates. The Fed can also directly affect the discount rate, which is the interest rate that the Fed charges other banks. A higher interest rate will influence banks to lend less money, as part of a tight money policy. A lower interest rate will lead to more loans, as part of an easy money policy.
  • The Fed consists of seven members who are appointed by the president and approved by the Senate.
  • Members serve for 14-year terms and cannot be removed without cause
  • 1,2,3 above are all used to change the supply of money and interest rates
  • Its decisions are relatively isolated from the influence of the executive and legislative branch
  • It is insulated from the public
    • In order to protect it from trying to appease the public
  • Somewhat independent
  • Regulates the supply and price of money
  • Sets monetary policy: the effort to shape the economy
  • Note: The Federal Reserve isn't a government agency. It may say "Federal" in its title, but it is a private organization for the most part.

Structure of the Federal Reserve Board
Federal Reserve Board (7 members) - The seven members of the Federal Reserve Board are appointed by the President and then approved by the Senate. They serve 14 year nonrenewable terms and can only be removed with a cause. (Wilson 501)
  • Determines how many government securities will be bought or sold by regional and member banks
  • Determines interest rates to be charged by regional banks and amount of money member banks must keep.

Regional Federal Reserve Banks (12)
  • Buy and sell government securities
  • Loan money to member banks
  • Keep percentage of holdings for member banks
  • Each Federal Reserve Bank has a board of directors, whose members work closely with their Reserve Bank president to provide grassroots economic information and input on management and monetary policy decisions as well as appoint the presidents of the Reserve Banks.
  • The Federal Reserve Banks are also subject to oversight by a Board of Governors, a seven member board that acts as the main governing body of the Federal Reserve System.
  • The Regional Federal Reserve Banks exist in the following cities: San Francisco, Cleveland, Philadelphia, Richmond, Atlanta, Boston, St. Louis, Kansas City, New York, Minneapolis, Dallas, and Chicago.

Member banks (6,000)
  • Buy and sell government securities
  • May borrow money from regional banks
  • Must keep percentage of holdings in regional banks
  • Interest rates paid to regional banks determine interest rate charged to business and personal loans and all bank rates.

Congressional Budget Act of 1974
Established procedures to standardize the budgeting process
President submits the budget in February.
CBO analyzes budget
Congressional committees, one from the House, one from the Senate, study the budget
Each committee submits a budget resolution-- a congressional decision that states the maximum amount of money that government should spend.
Congress is expected to adopt these resolutions in order to guide debates
Congress considers appropriations bills and sees if they are inline with the budget resolution
Did not automatically lead to spending cuts
Sequester: According to Wilson are automatic spending cuts across the board

Gramm-Rudman Balanced Budget Act of 1985
  • Previously called the Balanced Budget Act of 1985
  • Resulted from failure of 1974 Congressional Budget Act
  • Sometimes known as the Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Control Act of 1985, after its three chief sponsors
  • Later renamed after two of it's main sponsors, Phil Gramm and Warren Rudman, whom were both senators.
  • Democratic Senator Ernest Hollings also was a chief sponsor.
  • Automatic cuts from 1986-1991 until Federal deficit disappeared.
  • Lack of agreement between president/congress total standing level and resulted in a sequester.
  • President and congress found ways to increase spending
  • By 1990 it was clear that a new strategy was needed if the government was going to eliminate the deficit.
  • The strategy had two parts:
- congress voted for a tax increase
- the Budget Enforcement Act of 1990 imposed a cap on discretionary spending. As long as the President and congress stay under the spending cap, they can change the amount of money they spend.

Tax Reform Act of 1986
  • According to Wilson and Dilulio, instead of the high rates and big deductions, it changed to low rates and smaller deductions for businesses. This action ended up hurting businesses and the individuals came out on top. (pg 509)
    • A poll showed that people favored small cuts in tax rates coupled with many large deductions than favored big cuts in tax rates with fewer and smaller deductions.
1990 Budget Strategy
  • Congress voted for a tax increase and the Budget Enforcement Act capped non-entitlement (discretionary) funding.
  • Law does not limit mandatory spending, but impose a pay-as you go approach. If entitlement spending increased, cuts need to be made in discretionary spending or taxes had to be raised.
    • Combined effect of spending cap & pay-as-you-go policy helped restrain federal spending & to extent that government contributed to eliminating deficit (Wilson 505).
- In 1993 Clinton proposed another tax increase one that would raise the top rate to over 39% and make most Social Security benefits taxable for upper-income retirees. It narrowly passed. (Wilson)

Levying Taxes
  • Bills that have to do with revenue and finances must originate from the House of Representatives. The Senate is not granted the right to propose bills regarding finances.
  • The U.S. uses a progressive income tax system. As income rises so does percentage of income as taxes. Alternatively, the richer individuals must pay more in taxes than the poorer. The marginal rate is the tax rate that applies to the last dollar of income earned. There are different tax rates for each bracket of income. The average tax rate an individual pays in income taxes, is different from the marginal rate. The average tax rate is simply the total amount paid in taxes divided by total taxable income. [2]
    - Tax policy includes majoritarian politics, such as keeping tax burdens low and loophole use to a minimum, here everyone has to pay taxes, but also benefits from them. Client politics also is a factor here, such as the use of loopholes by some groups.
    • Majoritarian:( What is a 'fair' tax law)
    • Client : (How much is in it for me?)
    • According to Wilson, the law in short is viewed as good if it is imposed modest burdens, prevented cheating, & mildly progressive.
  • - Americans tend to evade paying their income taxes less than citizens of other countries, such as France and Italy, which is why these countries rely more on sales tax rather than income taxes, since a sales tax is much harder to dodge paying these taxes.
    • 16th Amendment (1913): Congress shall have power to lay and collect taxes on incomes.
  • -According to Wilson the United States tax burden is lower than in most other countries.
  • Tax rates tend to go up during wartime and down during peacetime.
    • During World War II the highest tax rate possible on taxable income became ninety-four percent. Therefore, the rich were affected more by this, but of course they did use loopholes, so that their income in the higher brackets was not taxes so heavily.
    • An implied agreement between the Republican and Democratic parties came to be that the Republicans would not press for lower tax rates, if the Democrats did not push for a reduction in the number of the loopholes. The division existed along the Democrats and Republicans, because the poor were more likely to be Democrat, while the rich were more likely to be Republican.
    • Loopholes became a part of client politics until 1986. The loopholes benefited the rich while the costs were distribute amongst a wide portion of society. The rich liked loopholes, because Congress did not vote on the matters each year, since the loopholes, as Wilson and Dilulio point out, were not subsidies. They were not argued about by Congress every year for appropriations by the House Committee on Appropriations. Therefore, once the loopholes, became instated they often remained. (Wilson and Dilulio 508). [3]
  • Keeping the burden low and the cheating at a minimum is an example of majoritarian politics: most people pay and most benefit.
  • -Loopholes can work in the advantage of the rich to avoid paying really high taxes which is an example of client politics.
  • How effective it is, is had to measure.
    -Many scholars believe that dramatically reducing loopholes is politically possible
    Fiscal Policy used by the Government
    Fiscal Policy: A policy that is to achieve full employment and a noninflationary output by adjusting government spending and taxes
Increased government spending is usually intended to stimulate the economy
- Fiscal Policy is used by the government while Monetary Policy is used by the Federal Reserve.

The Politics of Economic Prosperity
-Though it seems as if people would be only concerned about their own economic prosperity, it is a common trend in America that people see a correlation between their well being and the well being of other citizens. This lead people to vote for politicians that aim to bring overall economic prosperity.
- Likewise, before elections, politicians worry about the pocketbook issue. This concerns the well being of the economy which in turn concerns the chances of an incumbent being reelected with respect to current conditions.
- Low income people are more likely to worry about unemployment, causing them to vote democratic, and wealthier people will tend to vote Republican because they worry about inflation.
- According to Wilson and Dilulio, in presidential elections people who think that national economic trends are bad are more likely to vote against the incumbent, even if their own finances have not worsened.
-Voting behavior and economic conditions show a correlation at the national level but not at the individual level.
-People want conflicting things: no tax increases, continued/higher government spending on programs, no government deficit.
-As cutting taxes significantly is difficult, politicians are more likely to get reelected by spending more money on programs that are popular or considered necessary at the time.

Economic Health
-Even when our country is at a time of great prosperity, the future of our economy is uncertain.
There are times when the unexpected occurs during times of war or great depressions that may force our country into a time of poverty. Occurrences, like the September 11, 2001 attack on the two towers was an example of the effect of unexpected events having an effect on economic fluctuation.
- According to Wilson and Dilulio, the concept of economic planning (advocated by John Kenneth Galbraith) can help improve the economic health of a nation. Economic planning is the belief that government plans such as wage and price controls, or the direction of investment, can improve the economy.
  • Economic planning was used during both World Wars in order to create necessary production and distribution rates.
  • Economic planning usually does not happen in peace-time, usually because some critics believe that no one can predict the changing economic needs of a nation.
  • Reserve Board and Monetary Policy
  • Open Market Operations (buys and sells government securities)- People buy bonds because they have better interest rate than savings accounts.(Princeton Review)
  • Required Reserve Ratio (regulates the amount of money that a member bank must keep in hand as reserves)- raising the reserve shrinks the amount of money available for borrowing, which raises the interest rates. Lowering the reserve will have the opposite effect.
  • Discount Rate (changes the interest charged banks)- Lowering the discount rate will lower the interest rates for consumer loans and raising the discount rate will raise the interest rates for consumer loans.
The Short-Run Phillips Curve (blue) with a stagflatory shift (light blue / periwinkle) and a Long-Run Phillips Curve (red). Image courtesy of Wikimedia.
The Short-Run Phillips Curve (blue) with a stagflatory shift (light blue / periwinkle) and a Long-Run Phillips Curve (red). Image courtesy of Wikimedia.

Trade Off Between Inflation and Unemployment (Phillips Curve)
  • Inflation and Unemployment are inversely related in the short run.
    • If there is low inflation, there is high unemployment
    • If there is high inflation, there is low unemployment
    • Graphically shown on the Short Run Phillips Curve
  • The exception to this is known as stagflation (high unemployment and high inflation).
    • This is seen graphically as an outward shift of the Short Run Phillips Curve.
    • Stagflation is caused by what is known as a supply shock, where resources become extremely limited.
    • For example, consider the 1973 OPEC embargo that restricted the supply of oil, crippling production and generating stagflation.
  • The other exception occurs with economic growth, in which an economy can experience both low inflation rates as well as a low rate of unemployment.
    • This is seen graphically as a leftward shift of the Short Run Phillips Curve.
  • In the long run (i.e., at full employment), there is no trade-off between inflation and unemployment.
    • This is demonstrated graphically by the Long-Run Phillips Curve, which is vertical at the natural rate of unemployment.
Trade Policy
- Foreign nations as well as the United States are interdependent on each other for market products (Levy and Meltzer)
-The ratio of imported goods to exported products is defined as the balance of trade. (Levy and Meltzer)
- Trade deficits occur when there is excess imports over exports. (Levy and Meltzer)
- Trade deficits aren't necessarily bad as they may raise the standard of living in certain places that cannot get desired products on their own

When trade deficits occur, nations (including the US) tend to place import restrictions and tariffs. Trade wars can occur as a result of these unnecessary and sometimes unreasonable regulations.

GATT (General Agreement on Tariffs and Trade) was signed by the United States to promote trade. This eventually grew into the World Trade Organization (WTO).
  • GATT's main purpose was to reduce import tariffs and barriers to facilitate trade
  • The WTO replaced it and has around 157 members presently

NAFTA (North American Free Trade Agreement) (1993) was also signed in conjunction by the United States to increase trade and remove barriers of trade between Canada and Mexico.
  • it is argued that NAFTA is making it easier to send companies into Mexico for cheap labor and therefore less jobs here, something government often has to discredit or deal with.
  • NAFTA was not expanded to all of Latin America because of lack of public support
  • NAFTA has done things that reward economic interest groups such as companies that largely employ workers in Mexico and Canada

The Rise of the Income Tax
  • Federal income tax was not collected until the end of the nineteenth century with the exception being a small time frame during the Civil War (Wilson, 507).
  • Much of the money that was needed by the government came from tariffs (Wilson 507).
  • In 1913 the states approved the 16th amendment which allowed the government to impose an income tax, even though the Supreme Court had ruled it unconstitutional previously (Wilson 507).
  • Tax rates tended to go up during wartime and go down during peacetime. This pattern continued for roughly forty years after the creation of these taxes (Wilson 507).
  • "Marginal Rate": the percentage of the last dollar that must be paid out in taxes was at a rate of 94% during WWII for those in the highest tax bracket (Wilson)
  • Tax rates did not return to their pre-war levels after World War Two (Wilson, 507).
  • Until this time, the average citizen paid very little in income taxes (Wilson 507).
  • A poll had revealed that the people preferred small cuts in taxes with large deductions rather than large cuts with small deductions (Wilson, 508).
  • Tax Reform Act of 1986: Low tax rates with small deduction for mortgage interest and property taxes (Wilson 509).

  1. ^ Wilson, James Q., and John J. Dilulio. American Government: Institutions and Policies. Tenth ed. Boston, MA: Charles Hartford, 2006. Print.
  2. ^ Wilson, James Q., and John J. Dilulio. American Government: Institutions and Policies. Tenth ed. Boston, MA: Charles Hartford, 2006. Print.
  3. ^ Wilson, James Q., and John J. Dilulio. American Government: Institutions and Policies. Tenth ed. Boston, MA: Charles Hartford, 2006. Print.