16.5 Budgeting and Tax Policy

Economic theories shape U.S. fiscal policy, influencing how the government manages the economy. Keynesian, supply-side, and monetarist approaches offer different strategies for growth and stability, guiding decisions on taxes, spending, and monetary policy.

Congress wields significant economic influence through fiscal policy tools like taxation and spending. The federal budget process, involving the president and Congress, determines funding priorities and impacts domestic policies, while economic indicators guide policy goals.

Economic Theories and Fiscal Policy

Economic theories in U.S. policy

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• Keynesian economics
  • Advocates government intervention to stabilize the economy during recessions through increased spending and lower taxes to stimulate demand (New Deal programs)
• Supply-side economics
  • Focuses on increasing supply through tax cuts and deregulation arguing that lower taxes incentivize businesses to invest and produce more (Reaganomics)
• Monetarism
  • Emphasizes the role of money supply in determining economic growth and inflation advocating for steady, predictable growth in money supply to maintain economic stability (Federal Reserve policies)

Federal Budget and Domestic Policy

Congressional economic influence

• Fiscal policy tools
  • Taxation
    • Increasing taxes reduces disposable income and can slow economic growth
    • Decreasing taxes can stimulate spending and investment (Bush tax cuts)
    • Tax brackets determine the rate at which income is taxed at different levels
  • Government spending
    • Increasing spending can boost aggregate demand and create jobs (infrastructure projects)
    • Decreasing spending can reduce budget deficits and curb inflation (spending cuts)
• Automatic stabilizers
  • Policies automatically adjust based on economic conditions
    • Progressive income tax: higher tax rates for higher incomes, lower rates for lower incomes
    • Unemployment benefits: provide temporary income for unemployed workers
    • Welfare programs: provide assistance to low-income individuals and families (food stamps, Medicaid)

Federal budget and domestic policy

• Budget process steps
  1. Executive budget proposal
     • President submits a budget request to Congress outlining spending priorities and revenue projections
  2. Congressional budget resolution
     • Sets overall spending and revenue targets allocating spending among budget categories (defense, education, healthcare)
  3. Appropriations bills
     • Provide specific funding for agencies and programs
     • Must be passed by both houses of Congress and signed by the president
• Budget deficits and surpluses
  • Deficits occur when spending exceeds revenues leading to increased government borrowing and higher national debt
  • Surpluses occur when revenues exceed spending and can be used to pay down debt or fund new programs
  • A balanced budget occurs when revenues equal expenditures
• Impact on domestic policy
  • Budget decisions shape funding for social programs, infrastructure, education, and more (Social Security, Medicare)
  • Trade-offs between competing priorities can lead to political debates and compromises

Economic Indicators and Policy Goals

• Gross Domestic Product (GDP): measures the total value of goods and services produced within a country
• Economic growth: the increase in the production of goods and services over time
• Inflation: the rate at which the general level of prices for goods and services is rising
• These indicators influence budget and tax policy decisions to achieve economic stability and growth

Monetary Policy and Economic Regulation

Federal Reserve's economic role

• Monetary policy tools
  • Setting the federal funds rate
    • Influences short-term interest rates throughout the economy
    • Lower rates stimulate borrowing and spending; higher rates slow economic growth
  • Open market operations
    • Buying or selling government securities to control money supply
    • Buying securities increases money supply; selling securities decreases it
  • Reserve requirements
    • Determines the amount of money banks must hold in reserve
    • Higher requirements reduce lending capacity; lower requirements increase it
• Regulation of the financial system
  • Supervises and regulates banks to ensure stability and prevent failures (stress tests, capital requirements)
  • Enforces consumer protection laws related to financial products and services (Truth in Lending Act, Fair Credit Reporting Act)
• Dual mandate
  • The Fed is tasked with promoting both maximum employment and price stability
  • May require balancing trade-offs between the two goals depending on economic conditions (raising interest rates to combat inflation while considering employment impacts)