Role of Government in the
US Economy
A. Price stability – control inflation (2-3% per year)
B. Full employment – 5% (or less) unemployment rate
C. Economic growth – 3% per year
D. Economic opportunity – eliminate discrimination
E. Economic freedom – promote competition and fair business practices
F. Economic security – protect citizens from adverse events (safety net)
G. Regulating businesses – use of regulatory agencies to prevent abuse
2. Occupational Safety and Health Administration (OSHA) – set standards for working conditions
4. Consumer Product Safety Commission (CPSC) – safety standards for products, such as toys
5. Federal Trade Commission (FTC) – ensure that business practices are fair
6. Federal Communications Commission (FCC) – regulate airwaves, advertising
7. Securities & Exchange Commission (SEC)
– supervises the sale of stocks
II. Taxation
A. Guidelines to taxation (Adam Smith)
1. Taxes should be…..
a. based on ability to pay
b. clear and straightforward
c. collected in the most convenient way possible
d. collected efficiently
1. Income taxes
a. not mentioned in Constitution
b. allowed under the 16th Amendment (1913)
c. “pay as you go” = withheld from payroll check
d. 2 types of income tax
1. personal (1996: 38% of federal revenue)
2. corporate (1996: 10% of federal revenue)
2. Social Security taxes (1999: 33.5% of federal revenue)
a. authorized by Federal Insurance Contributions Act (FICA)
b. funds two social welfare programs
1. Social Security
2. Medicare
c. employee pays 7.65% on income up to $76,200 (lower rate after that)
1. employer matches contribution
3. Property taxes
a. main source of revenue for local governments
b. usually fund education (2000: 37% of local government spending)
c. based on value of property (Wake Forest: $.06 per $100 of value)
d. does not account for person’s income:
1. retired couple on fixed income live in area where property values skyrocket struggle to pay property tax
e. causes inequality in local funding of schools and other projects
4. Sales taxes
a. administered by state governments
b. tax on a wide range of goods
c. is a regressive tax because it applies to basic consumer spending, which takes up a
larger percentage of lower incomes
d. the amount of tax paid on items is the same for people with higher and lower
incomes, that amount is a greater % of a lower income than of a higher income
5. Excise taxes
a. administered by state governments
b. ax on selected goods (firearms, tobacco, alcohol, telephone)
c. at one time were known as “sin taxes”
6. Inheritance tax (Estate tax, “Death tax”)
a. placed on assets of person who has died; paid out of the estate
b. only charged to estates worth more than $675,000 (2000)
c. designed to encourage people to put money into economy rather than hoard it
7. Gift tax
a. charged on gifts exceeding $10,000 in value
8. Customs duty
a. tax on items brought into US (tariff)
Fiscal policy – spending, taxing, borrowing policies
Fiscal year – 12-month financial period that doesn’t typically match the calendar year (starts in October)
I. 2 main schools
of thought:
A. Supply side economics
B. Demand side economics
C. as supply of goods increases, their prices drop
D. increased production also require firms to hire additional workers
E. workers spend more money, which increases demand
F. government role in the economy:
1. cut taxes to encourage individuals and businesses to invest
2. this produces additional disposable income and corporation profits, some of which will be invested.
3. increased tax revenues from new/expanded businesses will offset loss of revenue from tax cuts
G. Limits of supply side economics – critics challenge two assumptions made by supply-side theory
1. Economists believe they can predict economic behavior, however that is not always true
a. 1980s: economists assumed individuals and firms would invest the money gained through tax cuts. Instead, many people chose to spend this money, increasing overall demand and causing inflation.
2. Tax cuts are unfair
a. tax cuts of the 1980s benefited the wealthy more than the poor
b. spending cuts made as a result of government revenue loss fell most heavily on social programs for the poor & unemployed.
A. achieve economic growth by increasing demand for products and services
B. changes in demand cause fluctuations in the business cycle:
1. demand decreases = businesses produce fewer goods = lay off workers = economic slowdown
C. active government involvement is necessary to achieve full employment and improve a sluggish economy
D. Employment Act of 1946
1. pledged to promote “maximum employment, production, and purchasing power in the US economy.
2. it made economic growth and stability a goal of the federal government
E. Limits of Demand Side
1. more government spending = higher taxes or deficits
2. increased regulation and government interference in the market
A. Tax Rates
1. people lose jobs, which will force them to lower their expenses = people lower their demand for goods and we move toward recession.
a. the government reduces tax rates to offset loss of income due to unemployment
2. the government might raise tax rates to limit inflation
B. Tax Incentives
1. special breaks given to businesses to encourage investment in new capital
C. Government Spending
1. reduce government spending to limit inflation
2. increase spending to help reduce unemployment
D. Public Transfer Payments
1. “income security” that provides a “safety net”
2. unemployment insurance, Social Security, Medicare, Medicaid
A. Federal Budget: government’s plan for the use of government revenue
B. Expenditures: items on which the government spends money
C. Deficit: more is spent than collected
D. National Debt: total amount the government owes (2000: $5.6 trillion)
E. Debt Ceiling: limit on the size of the national debt (set by Congress)
A. Office of Management and Budget (OMB)
1. Director of OMB asks federal departments and agencies to submit their budget requests
B. Director takes the request to the President, who adds his/her priorities
1. OMB staff works out the details
2. President approves the draft
C. Budget is submitted to Congress for approval
1. Congress rarely passes the original version of the budget
D. President signs budget into law
A. government must borrow money to make up for its deficits.
1. sell savings bonds/treasury notes to citizens
2. sell large bonds to banks, including the Federal Reserve
3. sell large bonds to businesses
4. sell bonds to large government trust funds
a. Social Security system can purchase bonds with its surplus (transfer of funds)
A. Social Security: 22.9%
B. National Defense: 16.5%
C. Income Security: 13.9%
D. Interest on Debt: 12.5% ($362 billion)
E. Medicare: 11.0%