Economic Policy

Taxes and spending are the major tools with which government implements policy.

A. Policymakers rely on economic theories to explain how the market economy works.

1. LAISSEZ-FAIRE economists believe that government interference with the laws of the market prevents the development of a strong economic system.

2. KEYNESIAN theory holds that government policy can alleviate the negative consequences of the expansion and contraction
of BUSINESS CYCLES.

a. Laissez-faire policies cannot do anything about ECONOMIC DEPRESSIONS or raging INFLATION.

b. Keynes explained that business cycle fluctuations result from imbalances between aggregate demand and productive capacity.

(1) AGGREGATE DEMAND is the money available in the economy to be spent on goods and services.

(2) The PRODUCTIVE CAPACITY is the total value of goods and services that can be produced when the economy works at full capacity.

(3) The GROSS NATIONAL PRODUCT is the total value of the goods and services actually produced.

c. Aggregate demand can be adjusted through fiscal and monetary policies.

(1) The government can use FISCAL POLICIES in two ways.

(a) It can increase demand by spending more itself or by cutting taxes.

(b) When demand is too great, the government can spend less or raise taxes.

(2) By increasing (or decreasing) the money supply, MONETARY POLICIES indirectly increase (or decrease) aggregate demand.

d. Most modern economies have resorted to the Keynesian technique of DEFICIT FINANCING to stimulate the economy during economic depressions.

e. In the United States, the COUNCIL OF ECONOMIC ADVISORS was created to provide advice on maintaining a stable economy.

B. MONETARISTS question the political utility of Keynesian fiscal policies and favor reliance on monetary politics.

1. Government spending generally takes too long to enact and often cannot be stopped once started.

2. As an independent board, the governors of the FEDERAL RESERVE SYSTEM (the "Fed") can control the nation's financial decisions without regard to political pressure.

3. The Fed controls the money supply through three basic activities.

a. Setting reserve requirements for banks.

b. Changing the discount rate.

c. Buying and selling government securities.

4. Because the Fed operates independently of the president, problems of economic coordination often arise.

C. SUPPLY-SIDE ECONOMICS represents a return to laissez-faire ideas of less government regulation and less taxation.

1. Supply-siders believe that tax cuts stimulate investment and increase productivity, which ultimately produces more tax revenue.

2. Inspired by supply-side theories, Reagan sought and got massive tax cuts in 1981.

3. Although inflation was greatly reduced under Reagan, the budget deficit increased sharply--contrary to predictions of supply-side economists.

II. The budget is the tool by which expenditures for public policies are decided.

A. Since 1921, the president has been responsible for drafting the budget and submitting it to Congress for approval.

B. Broadly speaking, the budget states how much money government agencies will be allowed to spend on their programs.

1. The budget applies for the FISCAL YEAR (October 1 to September 30).

2. BUDGET AUTHORITY refers to how much money agencies are authorized to spend.

3. BUDGET OUTLAYS refer to how much money agencies are expected to spend.

4. The differences between RECEIPTS--expected taxes and revenues--and total spending is the budget deficit.

C. The preparation of the budget is supervised by the OFFICE OF MANAGEMENT AND BUDGET (OMB).

1. During the spring, OMB meets with the president to discuss the economic situation and budgetary priorities.

2. By the summer, government agencies are ready to prepare budgets in agreement with OMB guidelines.

3. During the fall, OMB analyzes agency requests while political negotiations try to defend their own programs.

4. The final budget is printed and presented to Congress by January 1.

D. The budget must then be passed by Congress.

1. The traditional committee structure has been retained in today's budget process.

a. TAX COMMITTEES are responsible for raising the revenue to run government.

b. AUTHORITARIAN COMMITTEES have jurisdiction over spending in a particular legislative subject matter.

c. APPROPRIATIONS COMMITTEES decide which programs passed by the authorization committees get funded.

2. In 1974 Congress regained some control over the budget process by creating new BUDGET COMMITTEES to supervise a new comprehensive budget review process.

a. THE CONGRESSIONAL BUDGET OFFICE (CBO) was created to allow Congress to present credible alternative budgets.

b. The new budget procedures have allowed Congress to structure the budget as a whole at the expense of failing to meet Congress's own deadlines.

3. The Gramm-Rudman-Hollings Act of 1985, or GRAMM-RUDMAN for short, mandated that the budget deficit be lowered to a specific level each year until the budget was balanced in 1991.

a. If Congress was unable to meet the deficit targets, the cuts would be automatically of important projects.

b. The use of across-the-board cuts in 1986 resulted in the under funding of many important projects.

c. In 1987, Congress and the president reduced the GRAMM-RUDMAN targets.

4. The Budget Enforcement Act of 1990 drew distinctions in spending that drastically altered the significance of the new deficit targets.

a. DISCRETIONARY SPENDING was defined as authorized expenditures from annual appropriations.

b. MANDATORY SPENDING was defined as expenditures required by previous commitments.

c. Spending was made mandatory for ENTITLEMENT programs (such as social security) that provide benefits to individuals legally entitled to them.

d. PAY-AS-YOU-GO restrictions were imposed on mandatory spending and taxes.

e. If Congress fails to limit discretionary spending to its cap in any year or violates pay-as-you-go restrictions, a SEQUESTRATION, or across-the-board spending cut, will automatically occur in the overspent category.

I. Tax policies are designed to provide a continuous flow of revenue without annual legislation.

A. Nevertheless, tax policy is often adjusted to meet budgetary outlays, to make the tax burden more equitable, or to control the economy.

1. The tax reform bill passed in 1986 represented one of the more sweeping changes in tax history.

a. The 1985 tax code included fourteen tax brackets, ranging from 11 to 50 percent.

b. Under the 1986 law, there were only two brackets: 15 and 28 percent.

c. Many tax "loopholes" were eliminated.

d. The new tax policy approached a flat tax, or single tax rate, which violates the principle of PROGRESSIVE TAXATION by which the rich pay proportionately higher taxes than the poor.

2. Bush first allied himself with Reagan's tax policy and promised "no new taxes," but eventually accepted the need for "tax revenue increases."

3. Public opinion studies show that in 1984 only a small minority of the American public considered the federal income tax system a major economic problem.

B. The tax burden has increased over time in the United States but is still low compared to the tax rate of major industrialized democratic nations.

II. Unlike tax policies, which usually do not vary from year to year, government spending is subject to annual appropriations.

A. The largest expense categories in President Clinton's FY 1995 budget included

1. Twenty-two percent for social security.

2. Just under 20 percent for defense.

3. Nearly 14 percent just for interest on the federal debt.

B. Most federal spending has gone to two major categories.

1. From the early 1940s to 1971, the largest portion of the budget went for defense expenditures.

2. Beginning in 1971, the largest expense in the federal budget has been payments to individuals, with social security the
largest component of that spending.

C. The large increase in the percentage of federal spending relative to GNP from World War II to the present (15 to 25 percent) is explained by bureaucratic and political factors.

1. INCREMENTAL BUDGETING produces a sort of bureaucratic momentum, which continually pushes up federal spending.

a. Bureaucrats base their budgetary requests on what they got last year plus some increment to fund new projects.

b. Members of Congress pay more attention to the size of the increment than the total size of the agency's budget.

c. The huge budget deficit has substantially checked the practice of incremental budgeting.

2. Certain spending programs cannot be reduced because they are enacted into existing law or protected by powerful interest groups.

a. UNCONTROLLABLE OUTLAYS--payments that are made according to existing laws--represent about two-thirds of budgetary outlays.

b. Modifying existing laws and entitlements to reduce deficits is politically unpalatable.

c. Americans have become used to certain government benefits but they do not like the idea of paying more taxes for
them.

(1) A 1992 survey of voters showed that a majority rejected any decrease in any of twelve domestic program areas. The only area voters wanted cuts was in defense.

(2) In the same survey, clear majorities of both Republicans and Democrats wanted increased spending in three areas--fighting crime, providing education and AIDS prevention.

III. How have government spending and tax policies affected economic inequality in America?

A. TRANSFER PAYMENTS--government payments to individuals--have had a definite effect in reducing income inequality.

B. Although the tax burden of the federal income tax is progressive, the burden of other taxes is highly regressive.

1. The social security payroll tax is even up to a certain point, and there is no tax at all on incomes higher than that point.

2. State and local sales taxes are flat-rate taxes that impose a relatively greater burden on the poor, who spend nearly all they make.

3. The tax code contained many policies that favor the rich, such as lower tax rates on capital gains, no withholding on unearned income, and no federal tax for certain securities.

4. Despite the billions of dollars spent on social programs from 1964 to 1989, the gap in income between rich and poor has changed very little.

a. The lowest one-fifth of the families made 4.3 percent of the income in 1966 and 5 percent in 1989.

b. The top one-fifth of the families made 45.7 percent in 1966 and 44.1 percent in 1989.

c. The economic policies of the Reagan administration increased gains of the truly rich more than of the 20 percent in the top income group.

 C. The highly unequal distribution of income in American society can be analyzed from the perspective of two models of democracy.

1. The pluralist model accounts for well-funded and well-organized groups formulating tax and spending policies that serve their interests.

2. The Majoritarian model offers little hope for redistributing income, for public opinion studies show that most Americans favor more regressive forms of taxation, such as a national sales tax or even a lottery, rather than an increase in income tax rates.

THE BUDGETARY PROCESS

This lecture focuses on the politics of the budgetary process. It gives some special attention to budgetary politics following passage of the Gramm-Rudman-Hollings deficit reduction act.

I. The process of preparing the federal budget has three important characteristics.

A. The process is intensely POLITICAL.

1. It involves allocations of scarce resources to satisfy diverse preferences.

2. It involves several key actors who play certain roles:

a. Lower-level government agencies act as advocates for their programs, seeking expansion of functions and therefore expansion of funds.

b. Agency requests are reported to departments, which seek to put the agency wants into broader perspective while still pushing their own political expansion.

c. THE OFFICE OF MANAGEMENT AND BUDGET (OMB) at the top executive level seeks to fit agency and departmental requests into the president's program--usually cutting requests in the process before they are included in the budget the president submits to Congress.

d. The House and Senate Appropriations subcommittees scrutinize budgetary requests, often changing them materially.

B. The process is extraordinarily COMPLEX.

1. Enormous sums are involved--nearly $1.2 TRILLION in FY 1990.

2. The budget is made annually--even for multiyear programs.

3. Many different actors are involved at various stages.

4. The overall process is highly decentralized.

C. The process is strongly INCREMENTAL.

1. Last year's budget serves as the base against which agency requests are evaluated, and change usually comes in piecemeal rather than in programmatic fashion.

2. There is relatively little effort to review existing programs thoroughly against alternatives, and OMB is limited in the amount of overall  coordination that it can achieve over the process.

3. Departures from Incrementalism are more likely to be "disjointed"--resulting from an uncoordinated pattern of political successes and failures due to the decentralized process of budget preparation.

II. A basic outline of the budgetary process is useful.

A. Some basic distinctions must be made concerning taxing and spending.

1. TAXATION refers to raising revenue to spend.

a. As required by the Constitution, revenue bills must originate in the House of Representatives.

(1) The committee charged with considering revenue bills is the Ways and Means Committee.

(2) Its chairman when the committee considered and passed the tax reform bill in 1986 was Dan Rostenkowski, Democrat from Illinois.

b. The Senate considers revenue bills after the House has taken action.

(1) The counterpart committee is the Senate Finance Committee.

(2) Its chairman during deliberations of the tax reform legislation was Robert Packwood, Republican from Oregon.

2. Several terms that deal with spending funds must be identified.

a. BUDGET AUTHORITY refers to how much money a government agency is authorized to spend on a program that has been approved by one of the subject matter committees of Congress.

b. BUDGET APPROPRIATION refers to how much money the agency is actually given to spend.

(1) This amount is determined by the separate action of the House and Senate Appropriations Committees, which report their recommendations to their chambers.

(2) Recommendations of the Appropriations Committees are embodied in thirteen different appropriation bills submitted to each chamber, and any differences in bills they pass must be reconciled.

c. BUDGET OUTLAYS refer to how much money an agency is actually expected to spend in a given year, with the understanding that not all the money requested for a multiyear project is expended in one year.

B. Congressional action on the budget begins when the president submits his budget to Congress.

1. According to the Budgeting and Accounting Act of 1921, the president is required to submit his budget on the fifteenth day of the new congressional session in January.

2. The president's budget is a huge document more than 500 pages long, and it is accompanied by a series of requests for appropriations for different government agencies.

C. Although the Constitution does not require that the House act first on appropriation requests, it does so by tradition.

1. Each request is assigned to one of thirteen subcommittees of the House Appropriations Committee:

Agriculture, Rural Development, and Related Agencies, Commerce, Justice, State, and Judiciary: Defense District of Columbia, Energy and Water Development, Foreign Operations, Housing and Urban Development

Independent Agencies - Interior, Labor/Health and Human Services, Education, Legislative, Military, Construction, Transportation, Treasury, Postal Service, General Government

a. Each subcommittee hold hearings on its requests for appropriations.

b. The subcommittee chairs are very influential: during the many years that conservative Democrat John J. Rooney (Brooklyn) headed the subcommittee on Commerce, Justice, State and Judiciary, the FBI got most of what it wanted, whereas the budget of the State Department was closely scrutinized.

c. Subcommittees in the House tend to cut most budget requests, on the theory that the agencies always ask for more than they need.

2. The full Appropriations Committee routinely accepts the recommendations of its subcommittees.

3. The House usually accepts the report of its Appropriations Committee, although objections are often made to particular items and alterations are occasionally made if they have sufficient support.

D. After the appropriations bills pass the House, they are sent to the Senate.

1. The bills are assigned to the Senate Appropriations Committee, which has thirteen subcommittees that parallel the subcommittees of the House Appropriations Committee.

2. Agencies that felt that they were unfairly treated in the House appeal to the Senate subcommittees, which often restore particular cuts.

3. Thus, the dual consideration of agency appropriations--first in the House, then in the Senate--sets up the Senate committee as a court of appeal and promotes pluralist politics in budget making.

E. The appropriations bills passed by the House and Senate always differ in minor items and often in major amounts.

1. Differences must be resolved by representatives of both Appropriations Committees in a House-Senate conference committee.

2. Over the years, Congress has had difficulty in agreeing on its appropriations bills and in enacting all thirteen bills into law before October 1, the start of the fiscal year for which the appropriations apply.

3. The federal government has regularly relied on CONTINUING APPROPRIATIONS--resolutions passed at the start of a new fiscal year to continue spending at the same level of the previous year just to keep the government in business.

III. Most observers agree that the budgeting process of the federal government does not work very well.

A. In 1987, agreement on budget items failed to emerge and four continuing resolutions (temporary funding bills) were passed to keep the government operating.

B. When the temporary funding expired, many federal agencies sent their employees home and closed their doors to the public.

C. The outcome, which involved considerable public outrage, resulted in a $576 billion appropriations bill--and got government going again.

IV. An overall evaluation of the budgetary process reveals its suitability for pluralist rather than Majoritarian democracy.

1. Although the president's budget establishes spending priorities, what emerges from the congressional process is often quite different.

a. For example, Bill Clinton's original budget priorities included public works programs. Few of them survived Congressional budget debates.

b. These battles are particularly fierce when the president and Congressional leaders are of different parties or when a president's opinion ratings are low and he cannot claim public support for his budget priorities.

2. The highly decentralized, complex nature of the system offers interest groups numerous opportunities to challenge and ultimately reverse provisions in the president's original budget.

a. The appropriations subcommittees in particular exercise a type of minority rule within their areas of policy responsibility.

b. The need to pass appropriations bills separately in the House and Senate and then to resolve differences in conference committees also presents opportunities to change the budget.

3. Certainly this complicated process is not suited to Majoritarian government--if one regards the president as spokesman for the majority.

a. The rapid process of public opinion polls can help determine if the public supports or opposes a president's budget proposals.

b. Sometimes it is Congress that is more faithful to current public opinion.

c. One would need to define mechanisms for Majoritarian government before deciding how to reform the budgetary process to accord with it.

4. One need not decide, however, that issue to judge the current budgetary process as chaotic and nearly unworkable.