William_T._Bianco,_David_T._Canon]_American_Polit

552552 Chapter 15 | Economic Policy

overall economy fell during the Reagan presidency, which suggests that spending was

not the source of the budget deficits in the 1980s.^41 A similar relationship between a cut

in tax rates and a decline in revenue was observed after the Bush tax cuts in 2001.

While it is too early to know how the $1.5 trillion Trump tax cuts will play out, it

is clear that they were motivated by this same supply-side thinking. Clearly the tax

cut could not be justified on Keynesian grounds, given that the economy was at full

employment at the time of the tax cuts.

How Much Can Fiscal Policy Really Affect the Economy? Economists

continue to debate the extent to which fiscal policy can influence the economy. Two

factors have limited the effectiveness of fiscal policy. First, fiscal policies often cannot

be implemented quickly enough to have the intended impact on the business cycle—

the normal expansion and contraction of the economy. This is especially true when

one party controls Congress and the other controls the presidency, but it can also be the

case even during unified government.

The $787 billion American Recovery and Reinvestment Act of 2009, designed to

stimulate the economy and create jobs after the 2008 economic crisis, ran into problems

along these lines. Although the legislation had a limited immediate impact on the

economy, it is impossible to spend that much money (or implement tax cuts) without some

time lag. Of the $787 billion total, tax cuts comprised $288 billion; contracts, grants,

and loans were $275 billion; and one-time payments to Social Security recipients were

$224 billion. One year after the recovery bill was enacted, the government reported that

nearly 600,000 jobs had been saved, but only 34.6 percent of the money ($272.2 billion)

had been spent. Austerity policies at the state level also blunted the impact of the

stimulus; that is, at the same time that the national government was trying to stimulate

the economy, states were cutting spending and raising taxes to balance their budgets.

Republicans criticized the Democrats, who controlled Congress and the presidency at the

time, for spending too much money and not enacting policies that would have had a more

immediate effect (such as payroll tax cuts). Critics on the left, meanwhile, argued that the

stimulus wasn’t big enough. A payroll tax cut was implemented for 2011–2012 that reduced

the rate from 6.2 to 4.2 percent, putting an additional $1,000 in the pocket of the average

American household for each of those years.

business cycle

The normal pattern of expansion and

contraction of the economy.

FIGURE

15.4

0

02550

Tax rate (%)

75 100

$1

$2

$3

$4

$5

Total tax $6

revenue

(trillions)

The Laffer Curve

The Laffer curve shows the theoretical

relationship between the tax rate and

total tax revenue. How did this curve

contribute to the budget deficits of the

1980s?

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