Andrew Teas

1
Chapter 14 Economic Policymaking

• Andrew Teas
• Government 2302
• Houston Community College

2
Case Study Recession

• Late 2008 U.S. officially in a recession
• Recession economic slowdown characterized by
  declining economic output and rising unemployment
• Reason most economists blame overly-aggressive
  home mortgage lending, enabled by securitization
  of mortgage debt
• Subprime lending (high interest rates for high
  risk) profitable as long as rates stay low and
  home prices continue to increase
• But rates rose and prices fell

3
Is the Recession Over?
4
Is the Recession Over?

• updated 434 p.m. CT, Tues., Sept . 15, 2009
• WASHINGTON - Federal Reserve Chairman Ben
  Bernanke said Tuesday the worst recession since
  the 1930s is probably over, although he cautioned
  that pain especially for the nearly 15 million
  unemployed Americans will persist.
• Bernanke said the economy likely is growing now,
  but he warned that wont be sufficient to prevent
  the unemployment rate, now at a 26-year high of
  9.7 percent, from rising.
• From a technical perspective, the recession is
  very likely over at this point, Bernanke said.
• http//www.msnbc.msn.com/id/32858855/

5
Five signs Bernanke may be right

• The stock market is acting more like a bull than
  a bear. The Standard Poors 500 stock index is
  now up 58 percent from its March 9 low. Over the
  last sixty years, the market has bottomed a
  median of 5 months before the recession ended,
  says Sam Stovall, chief investment strategist at
  Standard Poors in New York. That would mean
  the recession came to an end at the end of
  August.
• 2. New claims for unemployment peaked on March 28
  when they hit 674,000. Now, they are down to
  550,000. Typically, after claims have peaked,
  the recovery is coming in four to eight weeks,
  says economist Bob Brusca of Fact and Opinion
  Economics in New York.
• 3. Many manufacturing sectors are finally turning
  up. On Wednesday, the Federal Reserve reported
  that industrial production rose 0.8 percent in
  August, the second consecutive monthly increase.

6
Five signs Bernanke may be right

• 4. Gasoline deliveries have risen for the past
  three months, after declining for over a year and
  a half. Although increased gasoline usage may be
  the result of low prices (compared with a year
  ago), it may also signal that more people are
  commuting or shopping. It could be a sign we are
  moving out of the recession, says John Felmy, an
  economist with the American Petroleum Institute
  (API) in Washington.
• 5. Demand for freight transportation is rising,
  according to the Freight Transportation Services
  Index (TSI) put together by the US Department of
  Transportation.
• The index, which measures the output of trucks,
  railroads, inland waterways, pipelines and air
  freight, rose 1.6 percent in July. This is the
  first increase since February and the largest
  since January 2008.
• Over the past 25 years, an upturn in this index
  has been coincident with upturns in the
  economy.
• http//features.csmonitor.com/economyrebuild/2009/
  09/16/recession-over-five-signs-bernanke-may-be-ri
  ght/

7
Five signs Bernanke may be wrong

• 1. UNEMPLOYMENT Consumers wont start shopping
  again in earnest as long as the unemployment rate
  is at 9.5 and threatening to break into double
  digits. People who are out of work cant spend,
  and people who fear being out of work wont
  spend.
• 2. SPARE CAPACITY Companies wont hire or buy
  equipment as long as they have lots of slack.
  Todays industrial production report revealed
  that the U.S. industrial capacity utilization
  rate fell in June to 68, the lowest since
  recordkeeping began in 1967. World Bank Chief
  Economist Justin Lin said today in South Africa
  that unless global overcapacity is reduced, we
  will face a deflationary spiral and the crisis
  will become protracted, according to Bloomberg.

8
Five signs Bernanke may be wrong

• 3. DEBT Household debt soared from two-thirds of
  GDP in the early 1990s to 100 at the end of
  2008. Simply getting debt back to three-quarters
  of GDP, the level of 2001, would require paying
  off 25 of all outstanding household debt, 3.5
  trillion worth. Paying down debt gets even harder
  when GDP is falling.
• 4. BOND VIGILANTES If fixed-income investors get
  nervous that the governments massive deficit
  spending will push up inflation, they will sell
  bonds and drive up interest rates. That would be
  a huge setback for home buying, car sales, and
  other rate-sensitive sectors.
• 5. DOUBLE DIP Even if the gross domestic product
  rises in the current July-September quarterand
  it mightoutput could very well fall again in the
  fourth as the effects of the stimulus tax cuts
  begin to fade.
• http//www.businessweek.com/the_thread/economicsun
  bound/archives/2009/07/five_reasons_it.html

9
Goals of Economic Policy

• Fund Government Services
• 2006 - 2.5 trillion to provide government
  services
• Encourage/Discourage Private Sector Activity
• Subsidies, incentives, excise taxes
• Redistribute Income
• Economic Growth with Stable Prices
• Monetary policy

10
Tax Revenues
11
Tax Revenues

• Individual Income Tax
• In 2008, the individual income tax generated 45.4
  of federal tax money, making it the single
  largest source of revenue for the federal
  government.
• Income tax is graduated, so higher-income earners
  pay a higher percentage
• Tax preference rewards certain behaviors with
• Tax exemptions (exclusion of some income from
  taxation)
• Tax deductions (reductions in the amount of
  income counted for tax purposes)
• Tax credits (reductions in the amount of
  calculated tax owed)

12
(No Transcript)
13
Tax Revenues

• Payroll Taxes
• More than 33 of federal revenues are collected
  from payroll taxes, making these the second
  largest revenue raiser for the federal
  government.
• Payroll taxes are paid to fund Social Security
  and Medicare programs.
• Corporate Income Tax and Other Revenue
• About 20.8 of federal revenue comes from a
  variety of taxes, including corporate income
  taxes and excise taxes
• Other miscellaneous sources of revenue

14
Issues in Government Finance

• Tax Burden
• Measured in proportion to the nations gross
  domestic product (GDP), the federal tax burden in
  2008 stood at about 17.6 of GDP.
• National, state, and local taxes combined equaled
  nearly 31.6 of GDP.
• Compared with the tax burden in other
  industrialized nations, such as the United
  Kingdom, Canada, France, Germany, and Italy, the
  tax burden of Americans is low.
• But some economists argue that Americas tax
  burden is too high and chokes off economic
  growth.

15
Figure 14.2 graphs both government receipts and
government expenditures relative to GDP from 1996
through 2008
16
Issues in Government Finance

• Tax Incidence and Tax Fairness
• Depending on the set of assumptions used by
  economists, the federal tax system is either
  slightly progressive or slightly regressive.
• The individual income tax is progressive, while
  payroll taxes are regressive.
• Considering that state and local taxes tend to be
  regressive, it is probably accurate to say that
  taxes in the United States are roughly
  proportional or somewhat regressive.

17
Issues in Government Finance

• Tax Reform
• The nations tax system is not without its
  critics and suggestions for reform.
• Some argue that the tax system should be more
  progressive.
• Others advocate simplifying the tax code by
  adopting a flat-rate personal income tax and
  eliminating most deductions.
• Another proposal calls for the replacement of the
  income tax with a national sales tax.
• A flat tax or a national sales tax would have the
  effect of shifting the burden of taxing downward
  toward lower-income taxpayers.

18
Laffer Curve
19
Issues in Government Finance

• The Bush Tax Reforms
• The Bush tax reforms reflected the presidents
  goal of increasing savings and investment.
• The cuts focused on upper-income taxpayers
  because they save money.
• This would make more money available for
  businesses to expand, thus, through helping the
  poor indirectly through job creation.
• Tax Policy in the Obama Administration
• In early 2009, President Obama signed a stimulus
  package that included tax reductions for lower
  and middle-income taxpayers. Tax increases for
  high-income earners are expected

20
Budget Deficit and Surplus

• Budget deficit - the amount of money by which
  annual budget expenditures exceed annual budget
  receipts
• Budget surplus - the sum by which annual budget
  receipts exceed annual budget expenditures.
• National debt - the accumulated indebtedness of
  the federal government
• How damaging are budget deficits? Economists
  disagree, but most agree that large deficits
  extract an economic cost

21
Budget Deficit and Surplus

• Budget Surplus, deficit
• National Debt

22
Government Expenditures
23
(No Transcript)
24
(No Transcript)
25
Government Expenditures

• Health
• Health care is the fastest-growing category of
  federal spending 23 of federal spending
• The largest federal health programs are Medicare
  and Medicaid 44 million Medicare participants
  in 2008 cost 454 billion.
• Federal health care costs have exploded because
  of inflation, changing demographics, AIDS,
  illegal drug use, and federal mandates.

26
Government Expenditures

• Social Security
• 20.9 of all federal expenditures in 2008
• Social Security was created in 1935 to provide
  limited coverage to workers upon retirement at
  the age of 65.
• It has been expanded over the years to include
  dependents as well as the disabled.
• In 1983, Congress and the president bailed out
  Social Security.
• Although the trust funds currently maintain a
  healthy surplus, without reform the system will
  face a funding crisis in years to come

27
Government Expenditures

• National Defense 20.6 of federal spending in
  2008, 3rd largest category
• Income Security 14.8 of federal spending,
  includes welfare, food stamps, SSI, EITC (earned
  income tax credit)
• Welfare reform has reduced welfare rolls, but
  former welfare recipients rely heavily on other
  programs
• Interest on the Debt
• Payment on the debt 7.9 of federal spending in
  2008
• In mid-2008, the national debt stood at 9.6
  trillion

28
The number of TANF (welfare) recipients has
fallen dramatically from 14.2 million in 1994 to
3.8 million in 2008
29
Fiscal Policymaking

• Ground Rules for Budgeting
• Entitlements An entitlement program is a
  government program providing benefits to all
  persons qualified to receive them under law
  (Social Security, Medicare, Food Stamps, etc.)
• Contractual Commitments money owed from
  previous commitments (the last congress signed a
  contract to buy an aircraft carrier)
• Budget Agreements multi-year spending agreements
  between Congress and a president

30
Fiscal Policymaking

• The Budget Process
• Usually in March, the Office of Management and
  Budget (OMB) sends spending level guidelines to
  the various executive branch agencies, to be
  followed by a period of negotiations.
• In November, 11 months before the beginning of
  the fiscal year, the budget process starts in
  Congress.
• When the president presents the budget to
  Congress in January, it is divided according to
  taxing and spending measures and referred to the
  appropriate committees.
• The spending side of the budget requires the
  enactment of both authorization and appropriation
  bills.
• In studying the budgetary process, political
  scientists use the incremental model of
  budgeting.

31
Monetary Policymaking
32
Monetary Policymaking

• What is monetary policy?
• Keynes
• Interest
• Federal Reserve Board
• Federal Open Market Committee

33
Monetary Policymaking

• Interest money paid for the use of money
• Monetary Policy - the control of the money supply
  for the purpose of achieving economic goals
• The Federal Reserve Board (Fed) is an independent
  regulatory commission that makes monetary policy
• In 2008-9, the Fed took extraordinary measures to
  try to limit the effects of the recession
  dropping interest rates to near zero, trying to
  create credit for borrowers

34
Conclusion Economic Policymaking

• Agenda Building
• Elected officials often use economic issues as
  the centerpiece of political campaigns
• Interest groups are heavily involved in issues
  surrounding government spending
• Policy Formulation and Adoption
• Complex process of negotiation among House and
  Senate members and the executive branch
• Policy Evaluation OMB, GAO, congressional
  committees constantly evaluate economic policy

35
(No Transcript)