G Study Guide: The Economy and Income Security

Module G: The Economy and Income Security

INTRODUCTION TO PUBLIC POLICY

Topics

• The Political Marketplace: The Foundation of the Economy

• Approaches to Managing the Economy

• Tools for Managing the Economy

• How Do Societies Ensure That Their Members Have Economic Security?

• How to Provide Income Security?

• Programs Designed to Provide Income Security

• Individual Preferences on Taxes and Redistribution

• The Federal Budget

• Reference: Democratic Policymaking, Cambridge, 2017

Questions

• Why is it difficult to arrange collective action institutions to support the widely agreed-upon idea that citizens should not fall below a basic income floor?

• Can governments manage their economies to achieve desirable goals?

• Is deficit spending by governments desirable?

• Is it equitable for some citizens not to pay income taxes?

• Can the Social Security program be redesigned to provide benefits more equitably and more affordably?

• Reference: Democratic Policymaking, Cambridge, 2017

The Political Marketplace: The Foundation of the Economy

Government Necessity

• Governments are considered necessary conditions for successful economies.

• Thomas Hobbes (1651) Quotes: "No arts; no letters; no society; and which is worst of all, continual fear, and danger of violent death: and the life of man, solitary, poor, nasty, brutish, and short."

• Governments provide:
    - Safety
    - Property Rights

• Democracies are relatively new and feature:
    - Competing groups
    - Different platforms on taxes, tax incentives, and distributions
    - Citizens can choose which group aligns with their interests

• Reference: Democratic Policymaking, Cambridge, 2017

Approaches to Managing the Economy

Assessing Economies

• Good vs. Bad Economies:
    - Indicators include economic growth, employment rate, inflation, and balance of trade.
    - Reference: Democratic Policymaking, Cambridge, 2017

Economic Growth

• Definition: The increase in the market value of goods and services produced by an economy.

• Indicator of economic health; negative growth rate signals recession.

• Growth attributed to:
    - Increase in physical resources (e.g., oil, water, minerals).
    - Increase in human resources (i.e., education, technology).

• Measured by:
    - Rate of increase in real GDP (adjusted for inflation).
    - Growth of GDP per capita (also known as per capita income).

• Reference: Democratic Policymaking, Cambridge, 2017

Sustainable vs. Unstable Growth

• While initial growth is beneficial, excessive rapid growth can lead to instability, especially when driven by new resources.

• Reference: Democratic Policymaking, Cambridge, 2017

Employment Rate

• Definition: The ratio representing the proportion of the working-age population that is employed.

• Heavily influenced by economic growth; job vacancies increase during growth periods and decrease during recessions.

• 0% unemployment is theoretically unattainable due to constant job transitions; a 4-5% unemployment rate signifies almost full employment.

• Reference: Democratic Policymaking, Cambridge, 2017

Inflation

• Definition: The decrease in purchasing power of money; high inflation results in increased costs for goods and services.

• Causes of inflation often include excessive money production or surplus in the economy.

• Reference: Democratic Policymaking, Cambridge, 2017

Balance of Trade

• Definition: The difference between exports and imports of a country.

• Positive balances can reduce dependence on foreign products but imports may offer access to lower-cost, higher-quality goods.

• Reference: Democratic Policymaking, Cambridge, 2017

Managing Economic Downturns

• Investigates methods to pull economies out of downturns.

• Reference: Democratic Policymaking, Cambridge, 2017

Approaches to Managing the Economy

Classical Approach

• Definition: The Classical or Laissez-faire model advocates minimal governmental intervention.

• Tenets include:
    - Supply and demand are sufficient regulatory mechanisms.
    - Economic self-regulation occurs over time; failures are seen as fluxes.

• Austerity measures during recessions include:
    - Lowering government spending due to diminishing tax revenue.
    - Avoiding further debt accumulation during downturns.

• Reference: Democratic Policymaking, Cambridge, 2017

Keynesian Approach

• Based on John Maynard Keynes' theories advocating deficit spending during recessions to stimulate economic activity.

• Encourages government spending to bolster employment and revive production when private sector demand is lacking.

• Austerity is viewed as detrimental, extending periods of economic struggle for citizens.

• Reference: Democratic Policymaking, Cambridge, 2017

Tools for Managing the Economy

Management Mechanisms

• Key strategies for managing the economy:
    - Monetary Policy
    - Fiscal Policy
    - Regulation

• Reference: Democratic Policymaking, Cambridge, 2017

Monetary Policy

• Managed by the Federal Reserve, which is led by a Chairperson selected by the President and approved by the Senate for a four-year term.

• Roles:
    - Setting discount rates affecting lending rates for banks.
    - Lower discount rates can lead to reduced interest rates for consumers, prompting economic expansion.
    - Conversely, high rates constrain economic growth.

• Reference: Democratic Policymaking, Cambridge, 2017

Fiscal Policy

• Components:
    - Taxing and spending, coordinated by the President and Congress.

• Reference: Democratic Policymaking, Cambridge, 2017

Regulation

• Defined as government intervention in business decisions or market outcomes.

• Types of Regulation:
    - Price setting: imposed limits on how much a good can cost.
    - Entry restrictions: only specific firms permitted to operate under criteria.
    - Service obligations: minimum operational standards for firms.
    - Oversight: scrutiny of corporate decision-making.

• Reference: Democratic Policymaking, Cambridge, 2017

Taxation

• Collective action problem: Society desires certain programs, but individual willingness to pay varies.

• Set tax schemes aimed at achieving governmental revenue and economic effectiveness.

• Tax system types:
    - Regressive: poor pay higher income fractions than wealthier individuals (e.g., sales and sin taxes).
    - Proportional: every individual pays the same tax fraction (examples include Russia, Saudi Arabia).
    - Progressive: low-income individuals pay lower fractions compared to high-income individuals (e.g., US, UK).

• Reference: Democratic Policymaking, Cambridge, 2017

Taxation Impact

• Discussion on whether tax increases yield better economic outcomes, or if tax reductions are preferable.

• Increased taxation could boost governmental revenue for jobs and assistance but could deter business investment, potentially leading to decreased growth and increased unemployment.

• Laffer Curve: A theoretical representation telling us about the optimal nexus between tax rates and economic activity, suggesting that optimal marginal tax rates are between 50% and 80%.

• Reference: Democratic Policymaking, Cambridge, 2017

Who Pays for Government?

• Income Inequality Data:
    - Categorized household incomes and federal taxes paid by quintiles with median earnings and average tax rates.
    - Various calculations of net tax rates and transfers received are provided across income groups.

• Reference: Democratic Policymaking, Cambridge, 2017

Unemployment

• Reported by the U.S. Bureau of Labor Statistics; shows significant variability across demographics.

• 2016 Unemployment Rates:
    - White men and women age 16 and over: 4.0%
    - Black or African-American men and women age 20 and over: 7.9%
    - White individuals aged 16-19: 14.1%
    - Black or African-American individuals aged 16-19: 24.8%

• Reference: Democratic Policymaking, Cambridge, 2017

Economic Security in Societies

Providing Economic Security

• Examines how to ensure that economic policies protect society’s least well-off members.

• Rawls (1971) “Veil of Ignorance”:
    - Decisions on resource distribution should be made without knowledge of one’s societal position to ensure fairness.
    - Maximizes resources to benefit the least advantaged.

• Utilitarianism:
    - Advocates for maximizing average benefit for citizens.

• Reference: Democratic Policymaking, Cambridge, 2017

Collective Action Problems

• Issues arising when individuals advocate for aiding the poor, yet reluctance exists in contributing voluntarily to social welfare programs without coercion.

• Reference: Democratic Policymaking, Cambridge, 2017

Provision of Income Security

Income Security Mechanisms

• Savings:
    - Encourages individuals to save during productive periods for use in less productive times.

• Comparison of savings rates:
    - Sweden: 12% of current earnings
    - US: 4.5%
    - Poland: -0.5%

• Reference: Democratic Policymaking, Cambridge, 2017

Income Inequality Overview

• Definition: Income inequality refers to the distribution of income across the population.

• High inequality indicates that a small portion of the population holds disproportionate wealth, while low inequality reflects more equitable wealth distribution.

• The U.S. is characterized by significant income inequality.

• Reference: Democratic Policymaking, Cambridge, 2017

Specifics on U.S. Income Inequality

• Reported household incomes by income rank reveal disparities across bottom and top income quintiles, leading to higher percentage shares for upper-tier households.

• Reference: Democratic Policymaking, Cambridge, 2017

Perceptions on Income Inequality

• Public sentiment generally acknowledges income inequality as problematic, though there is resistance to governmental interventions that may be perceived as redistributive.

• Reference: Democratic Policymaking, Cambridge, 2017

Social Programs

Social Insurance

• Defined as a system of mandatory contributions for government assistance during sickness, unemployment, etc.

• Benefits are conditional upon previous payments to social insurance programs, generally viewed positively by the public.

• Reference: Democratic Policymaking, Cambridge, 2017

Redistribution

• Involves transferring wealth from those with more to those with less; often perceived less favorably compared to social security and unemployment insurance programs.

• Reference: Democratic Policymaking, Cambridge, 2017

Economic Behaviors and Choices

Rational Choice vs. Altruism

• Reflective scenarios on whether individuals would share wealth with those in need, triggering discussions on fairness, societal norms, and personal motivations.

• Reference: Democratic Policymaking, Cambridge, 2017

Ultimatum Game Experiment

• Setup: Two players, one of whom decides how much to share of $10 with another who initially has $0.

• Outcome: Player 2 may accept the offer or reject it, leading both players to receive nothing if rejected.

• Reference: Democratic Policymaking, Cambridge, 2017

Dictator Game Experiment

• Similar to the Ultimatum Game, with Player 1 unilaterally deciding the distribution of $10 without input from Player 2.

• Reference: Democratic Policymaking, Cambridge, 2017

Support for Social Programs

• Findings indicate a general consensus favoring aiding the less fortunate, which supports the rationale for funding social programs through tax revenue allocations.

• Reference: Democratic Policymaking, Cambridge, 2017

Programs Designed to Provide Income Security

Social Security

• Benefits encompass assistive programs for retirees, unemployed, and disabled individuals.

• Key components:
    - Retirement Funds
    - Disability Funds
    - Medicare Funds

• Established in 1935 under FDR; funded via mandatory payroll taxes with a model of benefits based on community contributions, not need.

• Reference: Democratic Policymaking, Cambridge, 2017

Unemployment Insurance

• Non-needs-based entitlement initiated during the 1935 Social Security Act.

• Benefits cover 40-50% of lost wages for individuals jobless through no fault of their own, generally funded by state and federal payroll taxes.

• Available for a maximum of six months; potential moral hazard due to disincentivization of job seeking.

• Reference: Democratic Policymaking, Cambridge, 2017

Temporary Assistance for Needy Families (TANF)

• A mean-tested redistributive program aiding families with dependent children under the poverty line.

• Transition from Aid to Families with Dependent Children (AFDC) to TANF occurred in 1996, with provisions including a limit of 60 months lifetime assistance.

• Mandates job seeking within two years of enrollment; supports include cash, childcare, and education programs.

• Reference: Democratic Policymaking, Cambridge, 2017

Earned Income Tax Credits (EITC)

• Designed as a means-tested benefit that offers tax credits to incentivize employment for low-income individuals.

• Structurally operates as a negative income tax where taxpayers receive refunds if credits exceed owed taxes.

• Reference: Democratic Policymaking, Cambridge, 2017

Minimum Wage

• Instituted by the Fair Labor Standards Act of 1937, currently set at $7.25 as an income baseline for workers.

• Critiques argue that higher minimum wages deter hiring, while recent studies (Card and Kruger, 1994, 2000) counter this claim, indicating that raising minimum wages does not lead to elevated unemployment.

• Reference: Democratic Policymaking, Cambridge, 2017

Food Security - Supplemental Nutrition Assistance Program (SNAP)

• Also known as Food Stamps, SNAP is a means-tested entitlement program.

• In 2013, SNAP cost $76.4 billion, aiding 47.6 million Americans, with an average payment of $133/month.

• Reference: Democratic Policymaking, Cambridge, 2017

Housing Security

• Describes the significant burden housing costs pose on low-income individuals, with most of their income allocated to housing expenses.

• Recession impacts included exacerbated difficulties in housing affordability due to market crashes and fluctuating home values.

• Reference: Democratic Policymaking, Cambridge, 2017

Low-income Housing Support

• Government provision of public housing is limited, often due to local regulatory reluctance aiming to attract higher income residents.

• The Housing and Urban Development (HUD) agency provides limited subsidies and grants, generally preferring private market housing solutions.

• Reference: Democratic Policymaking, Cambridge, 2017

Individual Preferences on Taxes and Redistribution

Tax Preferences

• Explores variations in preferences regarding taxation and wealth redistribution based on personal circumstances and economic outlooks.

• Wealthy individuals generally support reduced taxes and redistribution, while poorer individuals and those unlikely to be wealthy favor increased taxes and redistribution.

• The study by Alesina and La Ferrara (2005) highlights the significance of beliefs on equal opportunities in shaping tax preference views.

• Reference: Democratic Policymaking, Cambridge, 2017

Survey Findings

• A table detailing factors affecting beliefs on income differences and governmental roles in reduction was included.

• Reference: Democratic Policymaking, Cambridge, 2017

The Federal Budget

Overview of the Federal Budget

• The federal budget for the fiscal year 2023 totals $6.1 trillion, representing 22.7% of GDP. It includes the following components:
    - Mandatory Spending: $3.8 trillion (13.9% of GDP)
    - Discretionary Spending: $1.7 trillion (6.4% of GDP)
    - Net Interest: $659 billion (2.4% of GDP)
    - Major areas of spending include Social Security ($917 billion), Medicare ($839 billion), and interest on the national debt.

• Revenue sources include individual income taxes ($2.2 trillion), payroll taxes ($1.6 trillion), and corporate taxes ($420 billion).

• Reference: Democratic Policymaking, Cambridge, 2017