ECON 2301 Unit 4
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Unit 4: Fiscal Policy

 

 

A.  Read the following selections from the Margin Notes by clicking on each link.

 

B.  Watch these presentations. When you click on one of the links below, a new screen will pop up. Use the scrollbar on the side of the new screen to navigate. You need Adobe Reader to view PDF files.

 

C.  (Optional) Read the following chapters from the textbook.

Chapters 11 - 13

 

D.  The following Optional Links will help you do better in your course but they are not required.

 

E.  Activity #3: Stabilize the Debt: An Online Exercise in Hard Choices (10 points)To Do Note

To start, it's worth thinking about the deficit as being two different deficits.

The first is the medium-term deficit, created by the Iraq and Afghanistan wars, the 2003 Medicare drug plan, the Bush tax cuts, the recession and the government’s responses, such as the stimulus. It’s a significant sum but it is much smaller, as a share of the economy, than the deficits that have hobbled Greece, Ireland and others. It is also smaller than the deficit this country ran from 1990 to 1994.

The medium-term deficit does not need to be closed immediately, while the economy remains weak. The co-chairmen of the bipartisan National Commission on Fiscal Responsibility and Reform, Erskine B. Bowles and Alan K. Simpson, called for a phased-in program of modestly higher taxes and cuts to social programs and the military. Some conservatives have criticized that plan for raising taxes at all, and some liberals dislike its emphasis on spending cuts and eliminating middle-class tax breaks.

However we close it, the medium-term deficit does not appear to pose a huge threat to the American economy. Simply letting all of the Bush tax cuts expire, not just those benefiting the affluent, would nearly do the job.

The long-term deficit is a wholly different story.

It comes from the projected growth of Medicare, Medicaid and, to a lesser extent, Social Security. It is the result of baby boomers’ having paid far less in taxes than they will draw in benefits. And the longer we wait to deal with it, the larger the interest on the national debt will become. That means deficit cutting will probably be a regular part of politics for the next couple of decades.

One obvious debate will be taxes versus spending. But relying exclusively on one would be extremely difficult. An approach based only on spending would mean deep cuts to programs that many Americans consider the essence of government: Medicare, Social Security and the military, among others. Closing the entire deficit through taxes would require enormous tax increases, mostly because Medicare spending is expected to continue growing much faster than income. To keep up, tax rates would have to keep rising.

The real issues, then, are how much taxes should rise, how much spending should be cut — and what kinds of each change should take place.

We could choose to raise taxes mainly on the rich, because their tax rates have fallen steeply over the last few decades while their pretax income has soared. Or, knowing that many of the rich still have higher tax rates than anyone else, we could start by saying goodbye to the Bush tax cuts on income below $250,000.

No matter what we decide, we must keep in mind the potential effects on economic growth. Arguably, economic growth is the most important yardstick for any plan, because growth can do much to reduce the deficit, as it did after World War II and in the 1990s.

That helps explain why many economists favor a version of tax reform that would lower marginal rates and close loopholes. Ordinary tax cuts have a mixed record on helping the economy; growth after the Bush tax cuts was mediocre, for example. But tax reform could discourage households and businesses from changing their behavior, often inefficiently, to qualify for tax breaks. The Bowles-Simpson plan suggests several reforms that would raise more tax revenue than today’s code and help close the deficit.

Of course, when economists say loopholes, they are including the deduction on home mortgage interest and other popular items. All of us would prefer generous benefits and low taxes. That’s the problem with deficit cutting: it involves painful choices, like the ones we’ll see in this assignment.

 

Step #1

That's where you come in. YOUR CHALLENGE: Stabilize the US Debt at 60% of GDP by 2024

There are four things you should keep in mind.

  1. We’re using percentage of the GDP, rather than a dollar amount, to measure the debt. Remember that GDP tells us what our total economy is worth, whether it is growing and by how much. Measuring debt as a percentage of GDP gives us a clearer picture of that debt in relation to our economy and to economic growth.  Such a calculation allows us to measure yearly economic growth while still keeping track of debt. Hypothetically, if debt exceeds GDP, then the debt has become completely unsustainable by all interpretations.

  2. There are two types of spending: direct or mandatory spending (outside of the appropriations process) and discretionary spending (budgeted during the annual appropriations process). Changes to mandatory spending programs – Medicare, Social Security, etc – require a special legislative process and are highly controversial. In general, mandatory spending programs are basically on automatic pilot and grow without check or review. This simulation does not make distinctions between discretionary and mandatory spending, and the actual processes required to make changes in those areas. It is simply designed to allow users to choose among the various options, and attempt to reach the 60% debt-to-GDP goal. (This will make a bit more sense to you if you'll look at the National Budget Process, the link to which is with the Optional Links above.)

  3. Remember that economic growth is the most important yardstick for any plan because growth can do much to reduce the deficit, as it has in the past. Keep our current economic situation in mind and don't make any budget decisions that might retard growth.

  4. Simulation data and options are updated periodically to reflect new budget estimates from the CBO and the OMB, and to remove options that have been enacted into law. That means we’re faced here with the same choices as Congress.

 

Step #2

Go to CRFB’s Stabilize the Debt Budget Simulator.

The screenshot below is of the simulation’s starting page. I’ve marked 6 things you should notice. (1) Read the introduction and (2) use the link to and read the FAQs. Pay close attention to (3) the small box in the middle. It tells you how to play the game. Make sure you understand the instructions. Below that, use the link to (4) learn more about the federal budget. The (5) column on the right keeps track of your progress. When you’re ready to start, (6) use the NEXT button.

Stabilize the Debt Budget Simulator starting page

 

When you’ve made your last budget decision, you’ll see a screen like the one below. Again, I’ve marked 6 things you should notice. At the top of the page, you’ll see (1) your final results, including (3) a breakdown of your decisions by category and type.  In the middle box, you have a chance to (2) submit your results and some demographic data to CRFB if you want to do so. Below that and very important is a link allowing you to (6) view or save as a PDF your choices. You will need this information for your report to me so save it before you do anything else. Finally, the column on the right shows (4-5) your final results.

Stabilize the Debt Budget Simulator ending page

 

Step #3

After working through the entire process and looking over your saved results, reflect back on what you did, why and how successful you were. Send me your results (#1 below) and a discussion of your choices in the simulation that addresses points 2-10 below. Your discussion should be thorough, specific, include relevant concepts from the course material and be free of spelling and grammar errors.

  1. Your Results (Give your specific numbers.):   Debt as a percent of GDP ___________________________

Savings relative to current law in billions ______________

The three categories with your largest cuts (in order)

(a) _______________ (b) _______________ (c) _______________

  1. Looking at the 3 categories in which you made your largest total program cuts, why did you choose those program cuts over others? Do you see any pattern in which programs you cut?

  2. Which individual program cuts and/or tax changes had the largest impact (in dollar terms) on reducing the deficit? How realistic would such changes be?

  3. How will your program cuts and/or tax changes affect specific groups (the elderly, students, environmentalists, savers, the poor, foreign aid recipients, producers, etc.)?

  4. What are the tradeoffs of preserving some programs while curtailing others?

  5. Would different program cuts have had less impact on people’s lives?

  6. Look at any program cuts you made in mandatory spending programs. The simulation allowed you to essentially treat all spending as discretionary spending but if you had been unable to make those cuts, how much would it have affected the amount of debt you were able to reduce?

  7. From where did your largest savings come – revenue increases or program cuts? Are you satisfied with that outcome?

  8. Which of your decisions might be perceived as being politically motivated?

  9. Make specific and detailed connections to course content. Always include course concepts in your work. If you're reading your margin notes and watching the presentations, you'll have plenty of material from which to choose on every activity.

 

Just for Fun

Although I think CRFB’s simulator is the best available right now, there are others. If you like this sort of thing you might be interested in trying some of the following.

The New York Times: You Fix the Budget

Federal Budget Challenge

Control the US Debt!

Balance the 2013 United States Budget

You fix the federal budget

 

Activity Submission Instructions

By the deadline shown in the Course Schedule on the main page of your syllabus:
  • Send your results and discussion containing the 10 points requested in the body of a new email to dramyglenn@earthlink.net

  • Put only your name and Activity #3 at the beginning of your email.

  • Be careful to use the correct subject line.

  • Late summaries lose one point per day late, including weekends and holidays.

 


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Copyright 1996 Amy S Glenn   
Last updated:   05/20/2017   0430

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