16

Economic
Policy
For decades the Republicans complained that the Democrats
were big spenders. But when a conservative Republican, Ronald
Reagan, entered the White House in 1981, he cut taxes and allowed
spending to increase. The government spent more money than it took
in. Yet in 1986 the Democrats, who had long complained that
corporations and rich people didn't pay enough in taxes, voted for a tax
reform bill that cut tax rates. In addition, politicians who had always
looked for new tax loopholes to let people escape some taxes voted to
close many existing loopholes.
For a decade or so, the politics of economic policy making was
turned upside down. People who were supposed to hate deficits voted
to create them; people who were supposed to want high taxes voted to
lower them; and people who loved tax loopholes voted to close them.
It made it hard to write a chapter like this one.
By the 1990s, however, order had been restored. A Republican
president (George Bush) unhappily went along with tax increases, and
a Democratic president (Bill Clinton) happily signed a bill to increase
them even more. The national deficit began to decline-but not because
spending had been cut,
only because taxes had been raised.
By the mid-1990s cutting the deficit had become a joint
endeavor of both President Clinton and a Republican-led Congress.
They had a lot of arguments, but mostly over who was cutting the
budget faster. Things got so testy that at one point Congress would not
pass spending bills the president would sign, and so the federal
government was partially shut down for a few days because there was
no money to pay many government workers. In 1997, Clinton and the
Republican congressional leaders agreed on a deficit reduction plan.
How do we explain all of these gyrations? The answer lies in
ourselves, the American people. In the early I980s voters thought taxes
were too high, and so the government cut them. As the deficit shot up
voters objected, and so politicians looked for ways (higher taxes,

mostly) to cut it. From a political point of view there are three kinds of
economic realities: the general health of the nation (as measured by
employment, inflation, and growth in incomes), the level and
distribution of taxes, and the amount and kind of government
spending. Voters and interest groups judge the government on the
basis of how well the economy is doing, how much they are paying in
taxes, and how much they are getting from government spending
programs. Economists may tell us that these three realities are closely
intertwined, so that a change in taxes or spending will affect inflation
or unemployment, and vice versa. But voters are not very interested in
these relationships and theories; they are interested in results. They
want economic growth, low taxes, high levels of government spending
on most programs, and no budget deficit. This confronts the
government with a problem: it may be impossible to achieve all of
these results simultaneously. To see why, we shall look at these three
economic realities.

Economic Health
Disputes about the economic well-being of the nation tend to produce
majoritarian politics. This may seem strange, since each individual
presumably cares most about his or her own material comfort. If that
were the case, we would expect each voter to support politicians who
offer programs to make that voter better off, regardless of what those
programs would or would not do for other voters. In fact, though,
people see connections between their own conditions and the
economic health of the nation and tend to hold politicians responsible
for those national conditions,
Everybody knows that just before an election politicians worry
about the pocketbook issue. We have seen in Chapter 8 that economic
conditions are strongly associated with how much success the
incumbent party has in holding on to the White House and to the seats
held by the White House's
party in Congress, But whose pocketbook are voters worried about?
In part, of course, it is their own. We know that low-income
people are more likely to worry about unemployment and to vote
Democratic, and higher-income people are more likely to worry about

inflation and to vote Republican.' We also know that people who tell
pollsters that their families finances have gotten worse are more likely
than other people to vote against the incumbent president.2 In 1980
about two-thirds of those who said that they had become worse off
economically voted for Ronald Reagan, the challenger, while over half
of those who felt that they had become better off voted for Jimmy
Carter, the incumbent.3 In 1992 people who felt economically pinched
were more likely to vote for Clinton than for Bush, Clinton campaign
aides often reminded each other, "It's the economy, stupid!"
But people do not simply vote their own pocketbooks. In any
recession the vast majority of people will still have jobs; nevertheless,
these people will say that unemployment is the nation's biggest
problem, and many of them will vote accordingly-against the
incumbent during whose watch unemployment went up.4 Why should
employed people worry
about other peoples unemployment?
By the same token, younger voters, whose incomes tend to go
up each year, often worry more about inflation than do retired people
living on fixed incomes, the purchasing power of which goes down
with inflation.5 In presidential elections those
people who think that national economic trends are bad are much more
likely to vote against the incumbent, even when their own personal
finances have not worsened.6
In technical language, voting behavior and economic
conditions are strongly correlated at the national level but not at the
individual level, and this is true both in the United States and in
Europe.7 Such voters are behaving in an "other-regarding" or
"sociotropic" way. In ordinary language, voters seem to respond more
to the condition of the national economy than to their own personal
finances.
It is not hard to understand why this might be true. Part of the
explanation is that people understand what government can and cannot
be held accountable for. If you lose your job at the aircraft plant
because the government has not renewed the
plant's contract, you will be more likely to hold the government
responsible than if you lose your job because you were always
showing up drunk or because the plant moved out of town.
And part of the explanation is that people see general economic
conditions as having indirect effects on them even when they are still

doing pretty well. They may not be unemployed, but they may have
friends who are, and they may worry that if unemployment grows
worse, they will be the next to lose their jobs.

What Politicians Try to Do

Elected officials, who have to run for reelection every few
years, are strongly tempted to take a short run view of the economy
and to adopt those policies that will best satisfy the self-regarding
voter. They would dearly love to produce low unemployment rates and
rising family incomes just before an election. Some scholars think that
they do just this.
Since the nineteenth century the government has used money
to affect elections. At first this mostly took the form of patronage
passed out to the party faithful and money benefits given to important
blocs of voters. The massive system of Civil War pensions for Union
army veterans was run in a way that did no harm to the political
fortunes of the Republican party. After the Social Security system was
established, Congress voted to increase the benefits in virtually every
year in which there was an election (see Chapter 17).
But it is by no means clear that the federal government can or
will do whatever is necessary to reduce unemployment, cut inflation,
lower interest rates, and increase incomes just to win an election. For
one thing, the government does not know how to produce all these
desirable outcomes. Moreover, doing one of these things may often be
possible only at the cost of not doing another. For example, reducing
inflation can, in many cases, require the government to raise interest
rates, and this in turn can slow down the economy by making it harder
to sell houses, automobiles, and other things that are purchased with
borrowed money.
--Congress can only push the president so far. If it fails to
approximate money, he can close down the government and
blame Congress.-If it were easy to stimulate the economy just before an election,
practically every president would serve two full terms. But because of
the uncertainties and complexities of the economy, presidents can lose

elections over economic issues that they do not manage to the

satisfaction of voters. Ford lost in 1976, Carter in 1980, and Bush in
1992. In all cases economic conditions played a major role.
All this means that politicians must make choices about economic
policy, choices that are affected by uncertainty and ignorance. Those
choices are shaped significantly by the ideological differences between
the two political parties over what ought to be the principal goal of
economic policy. Democrats and Republicans alike would prefer to
have both low unemployment and no inflation, but if they must choose
(and choose they must), then the Democrats attempt first to reduce
unemployment and the Republicans attempt to reduce inflation.8 This
is no hard-and-fast rule; some say that jimmy Carter, a Democrat, tried
so hard to cut inflation in 1980 that he lost the support of many liberal
Democrats, such as Edward Kennedy, who thought that he should be
worrying more about creating jobs. But the general tendency seems
clear: the Democratic party worries more about unemployment, the
Republican party about inflation.
This tendency mirrors to some degree what Democratic and
Republican voters want their parties to do. Polls regularly show that
those who think of themselves as Democrats are much more worried
about unemployment than those who think of themselves as
Republicans.9 (There is not as much of a difference between
Democratic and Republican voters in worrying about inflation.)
Because of these beliefs, voters concerned about unemployment not
only are more likely to vote against the incumbent but also are more
likely to vote Democratic.

Economic Theories and

Political Needs
Policies aimed at improving the economy as a whole are examples of
majoritarian politics. Benefits and costs are widely distributed, because
a healthy economy benefits almost everybody and a stagnant one hurts
almost everybody. As with most majoritarian issues, the president
takes the lead and is held responsible for the results. But as we have
seen, presidents do not always know what to do. The economy is an
extraordinarily complex, poorly understood set of interrelationships.

Nations that have tried to run this machine by central commands have
not done very well. Presidents thus become very dependent on the
advice of experts who claim to have an idea about how best to nudge
the machine in the right direction. For better or worse, presidents (and
governments) choose among competing economic theories.
There are at least four major theories about how best to manage
the economy. Each theory, if fully stated, would be quite complicated;
moreover, many experts combine parts of one theory with parts of
another. What follows is a highly simplified account of these theories
that highlights their differences.

Monetarism
A monetarist, such as economist Milton Friedman, believes that
inflation occurs when there is too much money chasing too few goods.
The federal government has the power to create money (in ways to be
described on page 508); according to monetarists, inflation occurs
when it prints too much money. When inflation becomes rampant and
government tries to do something about it, it often cuts back sharply
on the amount of money in circulation. Then a recession will occur,
with slowed economic growth and an increase in unemployment. Since
the government does not understand that economic problems result
from its own start-and-stop habit of issuing new money, it will try to
cure some of these problems by policies that make matters worse-such
as having an unbalanced budget or creating new welfare programs.
Monetarism suggests that the proper thing for government to do is to
have a steady, predictable increase in the money supply at a rate about
equal to the growth in the economy's productivity; beyond that it
should leave matters alone and let the free market operate.

Keynesianism
John Maynard Keynes, an English economist who died in 1946,
believed that the market will not automatically operate at a fullemployment, low inflation level. Its health will depend on what
fraction of their incomes people save or spend. If they save too much,
there will be too little demand, production will decline, and
unemployment will rise. If they spend too much, demand will rise too

fast, prices will go up, and shortages will develop. According to

Keynesianism, the key is to create the right level of demand. This is
the task of government. When demand is too little, the government
should pump more money into the economy (by spending more than it
takes in in taxes and by creating public-works programs). When
demand is too great, the government should take money out of the
economy (by increasing taxes or cutting federal expenditures). There is
no need for the governments budget to be balanced on a year-to-year
basis; what counts is the performance of the economy. Keynesians,
unlike monetarists, tend to favor an activist government.

Planning
Some economists have too little faith in the workings of the free
market to be pure Keynesians, much less monetarists. They believe
that the government should plan, in varying ways, some part of the
countrys economic activity. One form of economic planning is price
and wage controls, as advocated
by John Kenneth Galbraith and others. In this view big corporations
can raise prices because the forces of competition are too weak to
restrain them, and labor unions can force up wages because
management finds it easy to pass the increases along to consumers in
the form of higher prices. Thus during inflationary times the
government should regulate the maximum prices that can be charged
and wages that can be paid, at least in the larger industries.
In the mid-1980s inflation was not the problem that it once had
been, however; instead the automakers were cutting car prices and
labor unions were accepting wage reductions. This shift drew attention
to a different form of economic planning. Called an industrial policy,
it reflected the publics concern for the declining health of certain
basic industries such as steel and automobile manufacturing. People
thought that these .smokestack" industries would not recover through
market forces; what was needed instead was for the government
somehow to direct or plan investments so that either these industries
would recover or new and better industries would take their places.
Advocates of this form of

Planning, such as Robert Reich (who became secretary of labor in the

Clinton administration), often point to Japan as an example of a
country in which the government does direct industrial investments.

--Are Economists Ever Right? -The jokes about them are endless, George Meany, a labor
leader, once said that economics IS the only profession m
which you can rise to eminence without ever being right.
Rudolph Penner, onetime head of the Congressional Budget
Office (and himself an economist), quipped that economists
can't even predict what happened in the past. What Paul
Samuelson, a Nobel-prize-winning economist, once said about
the stock market could also be said about economists: they
have predicted nine of the last five recessions.
It is true that economists have not done a very good job
of predicting which way the economy would move in the years
ahead. In 1986, for example, the forecasts, made one year in
advance by fifteen leading economic forecasters (two in the
government. thirteen in the private sector), were in error by 25
percent in forecasting growth in the gross national product, by
nearly 99 percent in forecasting price levels (that is. inflation),
and by 19 percent in forecasting key interest rates.'
The government forecasters are the Office of
Management and Budget (OMB), part of the executive branch,
and the Congressional Budget Office (CBO), part of Congress.
Both tend to make overly optimistic predictions. For example,
both thought that economic growth in 1986 would be higher
than it was by an average of 44 percent.2
Does all this make economics useless? Not at all, any
more than meteorology is useless despite the inability of
meteorologists to predict the weather one year (or even one
week) in advance. Today economists measure, with growing
accuracy, what the economy is doing at any given moment. By
contrast, when Herbert Hoover was president, we had no
reliable information on how many people were unemployed or
how much money workers were making.
Moreover, economics remind us of some sensible
propositions that we forget at our peril: for example, that

everything has a cost, or in popular parlance that there is no

such thing as a free lunch. Finally, economists can use their
concepts of price and cost to explain (and even predict) how
parts of the economy will respond to specific changes in certain
conditions. For instance, higher interest rates will cause less
housing to be built.--

Of course there are many exceptions to these patterns. Many

advocates of so-called industrial policy are not socialists; some liberals
have become skeptical of Keynesian economics; and quite a few
conservatives think that supply-side economics is unrealistic. But in
general one's economic theory tends to be consistent with one's
political convictions.

Supply-Side Tax Cuts

"Reaganomics"

Exactly the opposite remedy for declining American productivity is

suggested by people who call themselves "supply siders." The view of
economists such as Arthur Laffer and Paul Craig Roberts is that the
market, far from having failed, has not been given an adequate chance.
According to supply-side theory, what is needed is not more planning
but less government interference. In particular, sharply cutting taxes
will increase people's incentive to work, save, and invest. Greater
investments will then lead to more jobs, and if the earnings from these
investments and jobs are taxed less. it will lessen the tendency of many
individuals to shelter their earnings from the tax collector by taking
advantage of various tax loopholes or cheating on their income tax
returns. The greater productivity of the economy will produce more
tax revenue for the government. Even though tax rates will be lower,
the total national income to which these rates are applied will be
higher.

When Ronald Reagan became president in 1981, he set in motion

changes in federal economic policies that were soon called
Reaganomics. These changes were not dictated by any single
economic theory but by a combination of monetarism, supply-side tax
cuts, and domestic budget cutting. The president wanted to achieve
several goals simultaneously-re-duce the size of the federal
government, stimulate economic growth, and increase American
military strength. As it turned out for him (as for most presidents), the
things that he wanted were not entirely consistent. Spending on some
domestic programs was reduced. These reductions slowed the rate of
growth of federal spending on these programs but did not actually
decrease the spending. Military spending was sharply increased (see
Chapter 21). The money supply was held under control in order to
combat inflation (at the price of allowing interest rates to rise). Finally,
and most important, there were sharp across-the-board cuts in personal
income taxes, but for many people these cuts were more than offset by
increases in Social Security taxes.
The effect of lowering taxes while increasing spending was to
stimulate the economy (by pumping more money into it) and to create
large deficits. The stimulated economy resulted in a drop in the
unemployment rate and a rise in business activity.
The large deficits increased dramatically the size of the national debt.
The effects of the tax cuts on productivity and investment were hard to
estimate and remain a matter of controversy.
John Maynard Keynes, had he been alive, would have been
startled. A conservative president (aided, of course, by Congress)
created a massive budget deficit that helped reduce unemployment-just as Keynes, a liberal, might have recommended. The Democrats,
taken aback, began for the first time to argue against large budget

Ideology and Theory

Each economic theory has clear political consequences, and so it is no
accident that people embrace one theory or another in part because of
their political beliefs. If you are a conservative, monetarism or supplyside tax cuts will appeal to you, be cause both imply that the
government will be smaller and less intrusive. If you are a liberal,
Keynesian economics will appeal to you, because it permits (or even
requires) the federal government to carry on a wide range of social
welfare programs. And if you are a socialist, economic planning will
appeal to you, because it is an alternative to the free market and the
private management of economic resources.

deficits. In 1984 the Democratic presidential candidate, Walter

Mondale, called for raising taxes to balance the budget-just as a
traditional conservative might once have done. In 1996, another
Democrat. Bill Clinton, committed himself to eliminating the annual
budget deficit.

The Machinery of
Economic Policy Making
Even if the president knew exactly the right thing to do, he would still
have to find some way of doing it. In our government that is no easy
task. The machinery for making decisions about economic matters is
complex and not under the president's full control. Within the
executive branch three people other than the president are of special
importance. Sometimes called the "troika,"* these are the chairman of
the
Council of Economic Advisers (CEA), the director of the Office of
Management and Budget (OMB),
and the secretary of the treasury.
*From the Russian word for a carriage pulled by three horses.

--Defining Some Economic

Terms
Fiscal policy An attempt to use taxes and expenditures to
affect the economy. A budget deficit means that the
government spends more than it takes in, thus pumping
more money into the economy. A budget surplus means
that the government takes in more than it spends, thus
draining money out of the economy.
Monetary policy An attempt to use the amount of money
and bank deposits and the price of money (the interest rate)
to affect the economy.
Fiscal year (FY) October I to September 3D, the period of
time for which federal government appropriations are
made and federal books are kept. A fiscal year is named

after the year in which it ends-thus "fiscal 1995" (or"FY

95") means the twelve-month period ending September 30,
1995.
*At one time every U.S. dollar could be exchanged for gold.
Today the dollar is backed chiefly by public confidence
rather than by a precious metal.*

The Federal Reserve Board

The Tools by Which the Fed Implements Its
Monetary Policy
1. Buying and selling federal government securities (bonds,
Treasury notes, and other pieces of paper that constitute
government IOUs). When the Fed buys securities, it in effect
puts more money into circulation and takes securities out of
circulation. With more money around, interest rates tend to
drop, and more money is borrowed and spent. When the Fed
sells government securities, it in effect takes money out of
circulation, causing interest rates to rise and making borrowing
more difficult.
2. Regulating the amount of money that a member bank
must keep in hand as reserves to back up the customer
deposits it is holding. A bank lends out most of the money
deposited with it. If the Fed says that it must keep in reserve a
larger fraction of its deposits, then the amount that it can lend
drops, loans become harder to obtain, and interest rates rise.
3. Changing the interest charged banks that want to borrow
money from the Federal Reserve System. Banks borrow from
the Fed to cover short-term needs. The interest that the Fed
charges for this is called the discount rate. The Fed can raise or
lower that rate; this will have an effect, though usually rather
small, on how much money the banks will lend.
Federal Reserve Board (7 members)
Determines how many government securities will be
bought or sold by regional and member banks.

Determines interest rates to be charged by regional

banks and amount of money member banks must keep
in reserve in regional banks.

Regional Federal Reserve Banks (12).

Buy and sell government securities.
Loan money to member banks.
Keep percentage of holdings for member banks.
Member Banks (6,000)
Buy and sell government securities.
May borrow money from regional banks.
Must keep percentage of holdings in regional banks.
Interest rates paid to regional banks determine interest
rates charged for business and personal loans and
influence all bank Interest rates.-The CEA, composed of three professional economists plus a small
staff, has existed since 1946. In theory it is an impartial group of
experts responsible for forecasting economic trends, analyzing
economic issues, and helping prepare the economic report that the
president submits to Congress each year. Though quite professional in
tone, the CEA is not exactly impartial in practice, since each president
picks members sympathetic to his point of view. Kennedy picked
Keynesians; Reagan picked supply-siders and monetarists. But
whatever its philosophical tilt, the CEA is seen by other executive
agencies as the advocate of the opinion of professional economists,
who despite their differences generally tend to favor reliance on the
market.
OMB was originally the Bureau of the Budget, which was
created in 1921 and made part of the executive office of the president
in 1939; in 1970 it was renamed the Office of Management and
Budget. Its chief function is to prepare estimates of the amount that
will be spent by federal agencies, to negotiate with other departments
over the size of their budgets, and to make certain (insofar as it can)
that the legislative proposals of these other departments are in accord
with the president's program. Of late it has acquired something of a
split personality; it is in part an expert, nonpartisan agency that

analyzes spending and budget patterns and in part an activist, partisan

organization that tries to get the president's wishes carried out by the
bureaucracy. Under President Reagan's appointee David Stockman it
became the device for making deep budget cuts in domestic spending.
The secretary of the treasury is often close to or drawn from the
world of business and finance and is expected to argue the point of
view of the financial community. (Since its members do not always
agree, this is not always easy.) The secretary provides estimates of the
revenue that the government can expect from existing taxes and what
will be the result: of changing tax laws, and he or she represents the
United States in its dealings with the top bankers and finance ministers
of other nations.
A good deal of pulling and hauling takes place among
members of the troika, but if that were the extent of the problem,
presidential leadership would the fairly easy. The problem is far more
complex. In 1978 one study found 132 separate government bureaus
engaged in formulating economic policy. They regulate business,
make loans, and supply subsidies. For example, as foreign trade
becomes increasingly important to this country, the secretary of state
(among many others) acquires an interest in economic policy. Onethird of corporate profits come from overseas investments, and onefourth of farm output is sold abroad.
The Fed Among the most important of these other agencies
is the board of governors of the Federal Reserve System (the "Fed").
Its seven members are appointed by the president, with the consent of
the Senate, for fourteen-year, nonrenewable terms and may not be
removed except for cause.
(No member has ever been removed since it was created in 1913.) The
chairman serves for four years. In theory, and to some degree in
practice, the Fed is independent of both the president and Congress. Its
most important function is to regulate, insofar as it can, the supply of
money (both in circulation and in bank deposits) and the price of
money (in the form of interest rates). In the box at left are shown the
means employed by the Fed to achieve this, and the structure of the
Federal Reserve System over which it presides.
Just how independent the Fed is can be a matter of dispute.
During the 1980 election Fed policies helped keep interest rates at a
high level, a circumstance that did not benefit President Carter's

reelection bid. On the other hand, whenever a president is determined

to change monetary policy, he usually
can do so. For example, the term of Fed chairman Arthur F. Burns,
appointed by President Nixon, came up for renewal in 1978. President
Carter, seeking to influence Burns's decisions, held out the prospect of
reappointing him chairman. When Burns balked, he was passed over,
and G. William Miller was appointed in his stead. Presidents (Truman,
Johnson, and Nixon were all able to obtain changes in monetary
policy. However, inducing the Fed to change its policy requires
influence, of which no president has an unlimited supply.
Congress The most important part of the economic policy-making
machinery, of course, is Congress. It must approve all taxes and almost
all expenditures; there can be no wage or price controls without its
consent; and it has the ability to alter
the policy of the nominally independent Federal Reserve Board by
threatening to pass laws that would reduce its powers. And Congress
itself is fragmented, with great influence wielded by the members of
key committees, especially the House and Senate Budget Committees,
the House and Senate Appropriations Committees, the House Ways
and Means Committee, and the Senate Finance Committee.
In sum, no matter what economic theory the president may
have, if he is to put that theory into effect he needs the assistance of (1)
many agencies within the executive branch, (2) 9Uch independent
agencies as the Federal Reserve Board, and (3) the various committees
of Congress. Though members of the executive and legislative
branches are united by their common desire to get reelected (and thus
have a common interest in producing sound economic growth), each
part of this system may also be influenced by different economic
theories and will be motivated by the claims of interest groups.
The effect of these interest group claims is clearly shown in the
debate over trade restriction. Usually the economic health of the nation
affects everyone in pretty much the same way-we are all hurt by
inflation or helped by stable prices; the incomes of all of us tend to
grow (or remain stagnant) together. In these circumstances the politics
of economic health is majoritarian.
Now suppose, however, that most of us are doing pretty well
but that the people in a few industries or occupations are suffering.
That is exactly what happened in the 1980s when various force
combined to hurt such basic U.S. industries as steel and such important

occupations as farming. Although economists differ over exactly what

went wrong, in general these sectors of the economy were hurt by
foreign competition (that is, foreign nations found it easy to sell things
here), the rising value of the dollar (as a result U.S. companies and
farmers found it hard to sell their products abroad), and over expansion
(many companies and farmers had gone heavily into debt to expand
production beyond what the market would support).
Under these conditions the politics of economic health will pit
one part of the country against another. People who want to buy things
made abroad-German automobiles, Japanese computers, Taiwanese
shoes oppose placing any restrictions on their ability to import these
things. By contrast, people who make American automobiles,
American computers, and American shoes will favor heavy restrictions
(such as quotas or tariffs). Economic health becomes subject to interest
group politics.
In 1988 Congress responded to these competing pressures by
passing a trade bill that put enough restrictions on foreign imports to
satisfy the protectionists but not so many as to outrage the advocates of
free trade. In the 1988 presidential election the worth of this legislation
was a big issue, not only between the Democratic and Republican
candidates but among the primary candidates within each party.

Spending Money
If only the economic health of the nation mattered, then majoritarian
politics would dominate, and so the president and Congress would
both work to improve economic conditions. Although they still might
work at cross-purposes because they held to different economic
theories, the goal would be the same.
But the government must also respond to the demands of voters
and interest groups. The trade bill was an example of that. While these
demands are no less legitimate than the voters' general interest in
economic health, they produce not majoritarian but client and interest
group politics.
The sources of this conflict can be seen in public opinion polls.
Voters consistently say that they want a balanced budget and lower
government spending. They believe that the government spends too

much and that if it wanted to, it could cut spending. When the
government runs a deficit, the reason in the voters eyes is that it is
spending too much, not that it is
taxing too little. But these same polls show that the voters believe that
the government should spend more on education, homelessness: child
care, crime control, and almost anything else that one can think of
(except welfare and food stamps).
The voters are not irrational, thinking that they can have more
spending and less spending simultaneously. Nor are they hypocrites,
pretending to want less spending overall but more spending for
particular programs. They are simply expressing a variety of concerns
and a theory about spending. They want a limited government with no
deficit; they also want good schools, cleaner air, better health care, and
less crime. They believe that a frugal government could deliver what
they want by cutting out waste. They may by wrong about that belief,
but it is not obviously silly.
What this means for the government is easy to imagine.
Politicians have an incentive to make two kinds of appeals: The first
is, "Vote for me and I will keep government spending down and cut
the deficit." The second is, "Vote for me and I will make certain that
your favorite program gets more money." Some people will vote for
the candidate be-cause of the first appeal, some will vote for him or
her because of the second. But acting on these two appeals is clearly
going to lead to inconsistent policies. Where those inconsistencies
become evident is in the budget.

The Budget
A budget is a document that announces how much the government
will collect in taxes and spend in revenues and how those expenditures
will be allocated among various programs. In theory the federal budget
should be based on first deciding how much money the government is
going to spend and then allocating that money among different
programs and agencies. That is the way a household makes up its
budget: "We have this much in the paycheck, And so we will spend X
dollars on rent, Y dollars on food, and Z dollars on clothing, and what's

left over on entertainment. If the amount of the paycheck goes down,

we will cut something out--probably entertainment."
In fact, the federal budget is a list of everything the government
is going to spend money on, with only slight regard (sometimes no
regard) for how much money is available to be spent. Instead of being
a way of allocating money to be spent on various purposes, it is a way
of adding up what is in fact being spent.
Indeed, there was no federal budget at all before 1921, and
there was no unified presidential budget until the 1930s. Even after the
president began submitting a single budget, the committees of
Congress acted on it separately, adding to or subtracting from the
amounts he proposed. (Usually they followed his lead, but- they were
certainly free to depart from it as they wished.) If one committee
wanted to spend more on housing, no effort was made to take that
amount away from the committee that was spending money on health
(in fact, there was no machinery (for making such an effort).
The Congressional Budget Act of 1974 changed his somewhat.
Now after the president submits his budget in January, two budget
committees--one in the House, one in the Senate--study the president's
overall package and obtain an analysis of it from the Congressional
Budget Office (CBO). Each committee then submits to its house a
budget resolution that proposes a total budget ceiling and a ceiling for
each of several spending areas (such as health or defense). Each May
Congress adopts, with some modifications, these budget resolutions,
intending them to be targets to guide the work of each legislative
committee as it decides what should be spent in its area. During the
summer Congress then takes up the specific appropriations bills,
informing its members as it goes along whether or not the spending
proposed in these bills conforms to the May budget resolution. The
object, obviously, is to impose some discipline on the various
committees. After all the individual appropriations are decided,
Congress then adopts a second budget resolution that "reconciles" the
overall budget ceiling with the total resulting from the individual
appropriations bills.
The loophole in this process is very large: there is nothing to
prevent Congress from ignoring its first budget resolution, passed in
May, and thereby making its second resolution, passed in September,
simply reflect the total of all the individual spending bills that it has
adopted. And sometimes Congress does just that. But the existence of

this formal budget process has made a difference, despite the loophole:
Congress is now conscious of how its spending decisions match up
with an overall total that, for reasons of economic theory and practical
politics, it wants to maintain.
When President Reagan took office, he and his allies in
Congress took advantage of the Congressional Budget Act to start the
controversial process of cutting federal spending. The House and
Senate budget committees, with the president's support, used the first
budget resolution in May 1981 not simply to set a budget ceiling that,
as in the past, looked pretty much like the previous year's budget but to
direct each committee of Congress to make cuts--sometimes deep cuts-in the programs for which it was responsible. These cuts were to be
made in the authorization legislation (see Chapter 13) as well as in the
appropriations.
The object was to get members of Congress to vote for a total
package of cuts before they could vote on any particular cut.
Republican control of the Senate and an alliance between Republicans
and conservative southern Democrats in the House allowed this
strategy to succeed. The first budget resolution ordered Senate and
House committees to reduce federal spending during fiscal 1982 by
about $36 billion-less than the president had first asked, but a large
sum nonetheless. Then the individual committees set to work trying to
find ways of making these cuts.
Note how the procedures used by Congress can affect the
policies adopted by Congress. If the Reagan plan had been submitted
in the old piecemeal way, it is unlikely that cuts of this size would
have occurred in so short a time, or at all. The reason is not that
Congress would have wanted to ignore the president but that, then as
now, Congress reflects public opinion on economic policy. As stated at
the beginning of the chapter, the public wants less total federal
spending but more money spent on specific federal programs. Thus, if
you allow the public or Congress to vote first on specific programs,
spending is bound to rise. But if you require Congress to vote first on a
budget ceiling, then (unless it changes its mind as it goes along) total
spending will go down and tough choices will have to be made about
the component parts of the budget.
That, at least, is the theory. It worked once, in 1981, but it did
not work very well thereafter. During the rest of the Reagan years the
budget process broke down in the warfare between the president and

Congress. President Reagan represented the part of public opinion that

wanted less government spending in general; most members of
Congress represented the part of public opinion that wanted more
spending on particular programs. The result was a stalemate. In 1984
the' budget resolution was not passed until late September (four
months late); in 1985, not until August (three months late). The
amount being spent every year (see Figure 16.3) was far in excess of
the amount coming in from tax revenues. Part of this gap existed
because taxes had been sharply cut in 1981. The responsibility was
bipartisan--a Republican president had proposed the tax cut and signed
the spending bills, and a majority of Senate Democrats had voted for
the tax cut and the spending bills.
The deficit grew to the point that even politicians eager to
please their constituents' demand for more services began to worry that
the economy's health might be in peril. Accordingly, in 1985 Congress
changed the budget process once again by passing the GrammRudman Balanced Budget Act (named after two of its sponsors,
Senators Phil Gramm [R., Texas) and Warren Rudman [R., New
Hampshire]).
Signed by President Reagan, the law created a plan whereby
the budget would automatically be cut until there was no longer a
deficit. Each year between 1986 and 1991 the deficit could not exceed
a specified, declining amount. If Congress and the president could not
agree on a spending plan within those targets, there would be
automatic, across-the board percentage cuts--called a sequester--in
federal programs except for certain exempt programs.* No one liked
the idea of automatic budget cuts. Senator Rudman called it a bad
idea whose time has come.
*The exempt programs were Social Security, interest on the
federal debt, veterans' benefits, food stamps, and various
other welfare programs.
In 1988 George Bush campaigned for the presidency on the
slogan Read my lips--no new taxes. But by 1990 it had become clear
that the White House and Congress could not agree on spending cuts
sufficient to meet the Gramm-Rudman limits for that year. As a result,
Washington faced the prospect of a sequester of close to $100 billion.
Everybody's favorite ox was going to be gored. The president and

congressional leaders hastily called a summit meeting. After much

shadowboxing the president's lips moved again, but this time they said
that there would have to be "increased tax revenues."
The first summit agreement was rejected by Congress (one more
measure of how little power congressional leaders have). After more
back-room, bargaining, a budget agreement was finally passed that
increased taxes, cut defense spending, and put in place new budgeting
procedures. The top tax rate went up from 28 percent to 31 percent,
gasoline taxes were raised by ten cents a gallon, tax deductions were
limited, and alcohol and tobacco taxes were increased. Hardly any
domestic spending programs were cut; indeed, even after the defense
cuts, total spending was scheduled to go up by almost 5 percent.10

Budget reforms
Hardly anyone is satisfied with how the federal government
makes spending decisions. It is a complex, cumbersome, and
time-consuming process, and in the end it does not produce a
true budget but merely a list of appropriations only loosely
related to how much money the government has to spend.
Two kinds of reforms have been proposed-procedural
and constitutional. In general liberals have preferred the
procedural changes and conservatives the constitutional ones,
but there are many exceptions.
Procedural Changes
1. Have Congress vote on a budget and pass appropriations
bills only once every two years. This would unclog the process
and lighten the workload.
2. Combine appropriations and authorization bills. At present
separate committees must approve the authorization for a
program and the appropriation for that program.
Constitutional Changes
1. Amend the Constitution to require a balanced budget. As of
1988 thirty-two states had passed resolutions asking Congress

to call a constitutional convention to consider a balancedbudget amendment This is only two states short of the number
needed to force Congress to call such a convention, which
would be the first since 1787. The amendment would allow an
unbalanced budget in wartime or whenever an extraordinary
majority in Congress voted for it One version of the
amendment would also limit increases in federal spending to
some percentage of the increase in national income.
2. Amend the Constitution to give the president a line item
veto, now possessed by the governors of forty-three states. This
would make it possible for the president to veto a specific item
in a bill without vetoing the whole bill. A mild version of a
line-item veto has been authorized by legislation, but the courts
may declare it unconstitutional.

Major Provisions of the 1993

Budget Reconciliation Act
Individuals

Created a fourth tax bracket, increasing the effective

top rate from 36 percent to 39.6 percent for upperincome taxpayers.
Phased out the personal exemption for upper-income
taxpayers.
Raised the portion of Social Security benefits subject to
taxation from 50 percent to 85 percent for individuals
making more than $34,000 a year and couples making
more than $44,000 a year.
Eliminated deductions for dues in any club organized
for business, pleasure, recreation, or other social
purposes.

Corporations

Increased top tax rate from 25 percent to 34 percent.

Reduced deductions for
-Business meals.

-Moving expenses.
-Travel expenses.
Eliminated deductions for lobbying expenses.

Minimum Tax

Increased the minimum tax on individuals by creating a

two tiered rate structure: a 26 percent rate for the first
$175,000 of a taxpayer's income and a 28 percent rate
for income above $175,000.
Relaxed the minimum tax on business by changing the
formula by which it is calculated.

The 1990 budget agreement was designed to permit the

Democratic Congress and the Republican White House to get through
the 1992 elections without having to make immediate spending cuts.
The agreement did little either to cut the deficit or to calm the raging
debate over tax increases versus spending cuts as the best means of
reducing the deficit. That debate exploded into all-out partisan warfare
in 1993 when the newly elected Democratic president, Bill Clinton,
offered a new plan to achieve substantial deficit reduction.
The Clinton administration claimed that its first budget,
approved in August 1993, would reduce the deficit by an estimated
$505 billion over five years, about half through spending cuts ($255
billion) and the other half through tax increases ($250 billion). By
comparison, tax increases accounted for only about one-third of the
deficit reduction achieved by the 1990 budget agreement. Among the
key provisions of the 1993 budget bill are the following:

An increase in the top tax rate from 31 percent to over 39

percent
An increase in the portion of Social Security benefits subject to
taxation from 50 percent to 85 percent for upper-income
retirees
About one-quarter of all spending cuts ($56 billion) to come
from Medicare. About $21 billion added to expand the earned
income tax credit, which goes to poor, working families

A 4.3 cents increase in the 14.1 cents per gallon federal

gasoline tax

Politically, the most significant feature of the 1993 budget bill

mirrors that of the 1990 budget agreement-namely, caps on
appropriations that mandate area-specific cuts to finance new
expenditures. The 1993 bill also capped discretionary spending at $539
billion in fiscal 1994 and allows such spending to increase to only
$549 billion by 1998.
In the early 1990s, following the collapse of the, Soviet Union,
there was much talk of a peace dividend--vast sums of money for
domestic spending freed up by cuts in post--Cold War defense
spending. By most estimates, however, the defense cuts in the 1993
bill were not even enough to let existing domestic programs grow at
the rate of inflation between 1994 and 1998, let alone to finance new
programs. Thus the 1990 and 1~3 caps on domestic spending
constituted a hard freeze meaning that any new domestic programs
must be paid for by cost-saving reforms or the elimination of existing
programs.
To say that Clinton had difficulty in getting the 1993 budget
bill passed is an understatement. The final bill was hammered out in a
grueling summer of negotiations. The president was forced to give
ground on several major provisions of his original plan, including his
call for a broad-based, $72 billion energy tax. During the often heated
debate, Republicans insisted that the bill relied too much on taxes and
not enough on spending cuts, while Democrats worried about the
domestic spending caps and argued that the bill was not generous
enough with the poor. Some members of both parties complained that
even if the plan's economic projections proved to be exactly on target,
it would slow the deficit only temporarily through 1997; then the
deficit would start galloping again.
When the political dust settled, the bill passed in the House on
August 5 by a vote of 218-216. Not a single Republican voted for the
package, and forty-one Democrats voted against it. The next day, the
Senate adopted the bill by a razor-thin margin of 51-5O, with Vice
President AI Gore casting the tiebreaking vote. Once again not a single
Republican voted for the bill. (It was the first time since 1945 that the
majority party in Congress had passed major legislation without a
single vote from the minority party.)

In 1997, Clinton had an easier time getting the budget

agreement. He persuaded Republican congressional leaders to support
a plan that would eliminate the annual budget deficit by the year 2002.
In return for this, he got them to agree to several new spending
programs. They, in turn, got him to agree
to certain tax cuts. What made it possible to claim that the deficit
would disappear even though spending increased was the productivity
of the American economy. There was a new increase in tax revenues
that resulted from prosperity. In short, few hard choices had to be
made.
Under any circumstances, cutting spending is no easy matter.
Strong pressures support every government program, and a large part
of the federal budget consists of expenditures that represent past
commitments that, politically and sometimes legally, cannot be
altered. Politicians speak of these as uncontrollable expenditures
because they involve contracts already signed, payments (such as
Social Security) that are guaranteed by law, and interest on the
national debt that must be paid if the government is to stay in business.
In Figure 16.4 we see how rapidly spending on Social Security and
Medicare has grown. Projections of the growth of federal spending
suggest that Medicare expenditures will in time exceed those for
Social Security and defense.
In 1985, a typical year, these relatively uncontrollable
expenditures accounted for about three-fourths of all federal outlays.
Of course some (such as Social Security) can be controlled if one is
willing to reduce benefits promised to individuals, but such an action
is quite risky. Most of the easily controllable expenditures are
concentrated in the national defense area, a fact that helps explain why
there is greater variation from year to year in spending on defense than
in spending on nondefense programs.
Just how difficult it is to cut federal spending is underscored by
the fact that one year after President Reagan was inaugurated, the
federal government was spending more than it had been before he was
elected. Although planned expenditures were cut, significantly
affecting some domestic programs, this cut did not reduce total federal
spending, or even total non-defense spending-it simply slowed the rate
of increase.
Indeed, it is almost impossible for any president to know by
how much he has cut the budget. Federal programs contain countless

provisions that automatically cause spending to increase or decrease

depending on economic conditions that cannot be foreseen. For
example, it has been estimated that a 1 percent increase in the
unemployment rate will cause the government to spend $7 billion
more than it had planned (in the form of unemployment and welfare
benefits) and to take in $12 billion less than it had hoped (because
people out of work do not pay taxes). In short, a small change in
unemployment can cause a $19 billion swing in the government's
budget. As someone has said, much of the government budget is on
automatic pilot.

Levying Taxes
Tax policy reflects a various mixture of majoritarian politics ("What is
a 'fair' tax law?") and client politics ("How much is in it for me?"). In
the United States a fair tax law has generally been viewed as one that
keeps the overall tax burden rather low, requires everyone to pay
something, and requires the better off to pay at a higher rate than the
less-well-off. The law, in short, was viewed as good if it imposed
modest burdens, prevented cheating, and was mildly progressive.
Americans have had their first goal satisfied. The tax burden in
the United States is lower than it is in most other democratic nations
(see Figure 16.5). There is some evidence that they have also had their
second goal met-there is reason to believe that Americans evade their
income taxes less than do citizens of, say, France or Italy. (That is one
reason why many nations rely more on sales taxes than we do they are
harder to evade.) Just how progressive our tax rates are is a matter of
dispute; to determine whether the rich really pay at higher rates than
the poor, one has to know not only the official rates but also the effect
of deductions, exemptions, and exclusions (that is, of loopholes).
Keeping the burden low and the cheating at a minimum are
examples of majoritarian politics: most people benefit, most people
pay. The loopholes, however, are another matter-all manner of special
interests can get some special benefit from the tax law that the rest of
us must pay for but, given the complexity of the law, rarely notice.
Loopholes are client politics, par excellence.

Because of that, hardly any scholars believed that tax reform

(dramatically reducing the loopholes) was politically possible. Every
interest that benefited from a loophole-and these included not just
corporations but universities, museums, states, cities, and investorswould lobby vigorously to protect it
Nevertheless, in 1986 a sweeping tax reform act was passed.
Many of the most cherished loopholes were closed or reduced. What
happened? It is as if scientists who had proved that a bumblebee could
not fly got stung by a flying bumblebee.
The Rise of the Income Tax
To understand what happened in 1986, one must first understand the
political history of taxation in the United States. Until almost the end
of the nineteenth century, there was no federal income tax (except for
a brief period during the Civil War). The money that the government
needed came mostly from tariffs (that is, taxes on goods imported into
this country). And when Congress did enact a peacetime income tax,
the Supreme Court in 1895 struck it down as unconstitutional.11 To
change this, Congress proposed, and in 1913 the states ratified, the
Sixteenth Amendment, which authorized such a tax.
For the next forty years or so tax rates tended to go up during
wartime and down during peacetime. The rates were progressivethat
is, the wealthiest individuals paid at a higher rate than the less affluent.
For example, during World War II incomes in the highest bracket were
at a rate of 94 percent. (The tax rate in the highest bracket is called by
economists the "marginal rate." This is the percentage of the last dollar
that you earn that must be paid out in taxes.)
An income tax offers the opportunity for majoritarian politics
to become class politics. The majority of the citizenry earn average
incomes and control most of the votes. In theory there is nothing to
prevent the mass of people from voting for legislators who will tax
only the rich, who as a minority will always be outvoted. During the
early decades of this century, that is exactly what the rich feared would
happen. Since the highest marginal tax rate was 94 percent, you might
think that that is in fact what did happen.
You would be wrong. Offsetting the high rates were the
deductions, exemptions, and exclusions by which people could shelter
some of their income from taxation. These loopholes were available

for everyone, but they particularly helped the well-off. In effect a

political compromise was reached during the first half of this century.
The terms were these: the well-off, generally represented by the
Republican party, would drop their bitter opposition to high marginal
rates provided that the less-well-off, generally represented by the
Democratic party, would support a large number of loopholes. The
Democrats (or more accurately, the liberals) were willing to accept this
compromise because they feared that if they insisted on high rates with
no loopholes, the economy would suffer as people and businesses lost
their incentive to save and invest.
For at least thirty years after the adoption of the income tax in
1913, only a small number of high-income people paid any significant
amount in federal income taxes. The average citizen paid very little in
such taxes until World War II. After the war, taxes did not fall to their
prewar levels.
Most people did not complain too much, because they, too,
benefited greatly from the loopholes. They could deduct from their
taxable income the interest they paid on their home mortgages, the
state and local taxes they paid, much of what they paid in medical
insurance premiums, and the interest they paid on consumer loans
(such as those used to buy automobiles). On the eve of the Tax Reform
Act of 1986, an opinion poll showed that more people favored small
cuts in tax rates coupled with many large deductions than favored big
cuts in tax rates coupled with fewer and smaller deductions.12
Interest groups organized around each loophole.
Home builders organized to support the mortgage-interest
deduction; universities supported the charitable-contribution
deduction; insurance companies supported the deduction for medical
insurance premiums; and automakers supported the deduction for
interest on consumer loans.
In addition to these well-known loopholes there were countless
others, not so well known and involving much less money, that were
defended and enlarged through the efforts of other interest groups: for
instance, oil companies supported the deduction for drilling costs,
heavy industry supported the investment tax credit, and real estate
developers supported special tax write-offs for apartment and office
buildings.
Until 1986 the typical tax fight was less about rates than about
deductions. Rates were important, but not as important as tax

loopholes. "Loophole politics" was client politics. When client groups

pressed for benefits, they could take advantage of the decentralized
structure of Congress to find well-placed advocates who could
advance these interests through low-visibility bargaining. In effect
these groups were getting a subsidy from the federal government equal
to the amount of the tax break. However, the tax break was even better
than a subsidy, because it did not have to be voted on every year as
part of an appropriations bill: once part of the tax code, it lasted for a
long time, and given the length and complexity of that code, scarcely
anyone would notice it was there.
Many of these loopholes could be justified by arguments about
economic growth. Especially low tax rates on a certain kind of
investment encouraged more investment of that kind. Deductions for
mortgage interest and property taxes encouraged people to own their
own homes and boosted the construction industry.
Then the Tax Reform Act of 1986 turned the decades-old
compromise on its head: instead of high rates with big deductions, we
got low rates with much smaller deductions. The big gainers were
individuals; the big losers were businesses. What happened?
The Politics of Tax Reform
What happened, in essence, is that majoritarian politics resurfaced in
the form of a demand for fairness. The old system of loophole politics
had created a situation in which some policy entrepreneurs could point
to both real and imagined scandals that enabled them to mobilize
majorities supporting change.
There were several kinds of entrepreneurs. Some were
professional economists who had been writing for years about the
inequities and inefficiencies of the old tax code. They complained that
high tax rates discouraged investment and risk taking by people who
could not take advantage of any existing loopholes. They argued that
many business decisions were being made not on the basis of what was
economically efficient but on the basis of what worked under the tax
law. Over time the weight of this professional opinion on taxes was
beginning to make itself felt, just as the weight of such opinion against
regulation of the airlines had made itself felt in the events leading up
to deregulation in 1978 (see Chapter 15). In the government these

economists found allies in the Treasury Department, the Council of

Economic Advisers, and the Congress.
Another kind of entrepreneur included people who had an
ideological commitment to supply-side economics. ThenRepresentative Jack Kemp was a leader of this group, whose members
argued that low tax rates would spur economic growth. They won an
initial victory in 1981 when the Reagan tax cut, which they endorsed,
was enacted by Congress (it cut the average tax rate by about 23
percent). The 1986 legislation was seen as another step in that
direction.
Still other entrepreneurs were those publicists and journalists
who liked to produce stories about "tax cheats." These often took the
form of lists of wealthy individuals or big corporations that had not
paid anything in taxes that year. Usually they had paid no taxes for
perfectly legal reasons-their deductions and exemptions were so large
as to leave them owing no tax. The people supported the idea of
deductions, but not when the system lets somebody get off owing
nothing. Opinion polls showed that a clear majority of the public
thought that the existing tax laws were "unfair."
For policy entrepreneurs to succeed, they must be able to motivate key
politicians. In 1986 the motives were there. Representatives Kemp and
Gephardt had presidential ambitions, and so they were willing to take
up the cause in order to advance their candidacies. The chairman of the
House Ways and Means Committee, Representative Dan
Rostenkowski, wanted to be Speaker of the House and saw in support
for comprehensive tax reform a way of becoming a stronger candidate
for that job (as it turned out, he lost to Representative Jim Wright).
The chairman of the Senate Finance Committee, Senator Bob
Packwood, had been chagrined by press attacks labeling him "Senator
Hackwood" for his prior support of various tax loopholes. The
Democratic leadership in Congress wanted to overcome the adverse
effect on public opinion created by the support that their 1984
presidential candidate, Walter Mondale, had given to raising taxes; tax
reform seemed a good way of making people forget tax increases.

Major Provisions of the

1986 Tax Reform Act

Individuals

Eliminated more than a dozen tax brackets. replacing

them with two basic brackets: 15 percent and 28
percent (Previously. the highest bracket was 50
percent.)
Removed several million poor persons from the tax
rolls altogether.
Increased the size of the personal exemption and
standard deduction for individuals and couples.
Retained deductions for
-Home mortgage interest.
-State and local taxes.
-Itemized charitable contributions.
Eliminated deductions for
-Interest on consumer loans.
-Sales taxes.
-Many tax shelters.
-Contributions to Individual Retirement Accounts
(depending on income and whether covered by
employer pension).
Made tax on capital gains same as tax on other income.

Corporations

Lowered top tax rate from 46 percent to 34 percent

Repealed the investment tax credit
Eliminated many tax loopholes.
Stipulated that only 80 percent of business meals and
entertainment can be deducted.

Minimum Tax

Stipulated that both individuals and corporations would

have to pay a minimum tax. even when their deductions
and exemptions would otherwise entitle them to pay no
tax.

What may have sealed the victory was the behavior of the client
groups who fought to keep their favorite loopholes. At congressional
hearings on the bill they would sometimes applaud when, in the early
negotiations, some pet loophole survived intact. Members of the
Senate Finance Committee finally rebelled at this, tore up the bill that
they had been considering, and voted overwhelmingly for a new bill
that eliminated many loopholes and cut rates. Within a few months the
bill was passed and signed (for its provisions, see the box on page
519).
Tax politics had come full circle. The original 1913 tax law had
been the product of majoritarian politics. Then, as the fight over rates
intensified, subsequent versions of the law became more the product of
client politics. In 1986 majoritarian politics reemerged to dominate the
proceedings. As with airline deregulation, civil rights, and (as we shall
see) foreign policy, ideas sometimes are more important than interests.
But in time, the old system began to reassert itself. Tax rates were
slowly increased from where the 1986 law had left them, and more and
more tax deductions were added to the law. By the mid-1990s, many
people were complaining that the
tax law had become so complex that the average person could no
longer figure out his or her own taxes.

SUMMARY
There are three economic factors that make a difference to voters; the
policies for each are fom1ulated by a distinctive type of policymaking. The first is the economic health of the nation, the second the
amount and kinds of government spending, and the third the level and
distribution of taxes.
National economic health has powerful effects on the outcome
of elections, as much through peoples perception of national
conditions as from their worries about their own finances. The politics
of inflation, unemployment, and economic growth tend to be
majoritarian. The president is held responsible for national conditions.
But he must meet that responsibility by using imperfect economic
theories to manage clumsy government tools controlled by divided
political authorities.

When economic ill health occurs in some industries and places

but not others (as a result of such forces as foreign competition), the
politics of economic health are shaped by interest group politics. Firms
that import foreign products or sell to foreign nations try to avoid trade
restrictions, while firms and unions hurt by foreign competition try to
impose such restrictions.
The amount of spending is theoretically determined by the
budget, but in fact the nation has no meaningful budget. Instead the
president and Congress struggle over particular spending bills whose
amounts reflect interest group and client pressures. In the 1980s those
pressures, coupled with a large tax cut, led to a sharp increase in the
size of the federal debt.
The general shape of federal tax legislation is determined by
majoritarian politics, but the specific provisions (especially the
deductions, exemptions, and exclusions) are the result of client-group
politics. The Tax Reform Act of 1986 was a remarkable example of
the reassertion of majoritarian politics over client-group pressures
made possible by policy entrepreneurs and political incentives.

SUGGESTED READINGS
Birnbaum, Jeffrey H., and Alan S. Murray. Showdown at Gucci Gulch.
New York: Random House, 1987. Lively journalistic account of
the passage of the Tax Reform Act of 1986.
Kiewiet, D. Roderick. Macroeconomics and Micropolitics. Chicago:
University of Chicago Press, 1983. Argues that citizens vote on the
basis of their estimate of national economic conditions as well as
their own financial circumstances.
Samuelson, Robert J. The Good Life and Its Discontents, New York:
Times Books/Random House, L995. A readable, intelligent
account of American economic life since the Second World War.
Schick, Allen. The Capacity to Budget, Washington, D.C.: Urban
Institute, 1990. Analysis of federal budget and spending policies.
Stein, Herbert. Presidential Economics: The Making of Economic
Policy from Hoover to Reagan and Beyond. New York: Simon &
Schuster, 1984. History, by a knowledgeable insider, of how

economists participate in making federal economic policy, with

special emphasis on the period since 1968.
Stein, Herbert, and Murray Foss. The New Illustrated Guide to the
American Economy, 2nd ed. Washington, D.C.: American
Enterprise Institute, 1995. A vivid collection of graphs, all clearly
explained, that describes the American economy and government
spending from the 1950s through the early 1990s.
Tufte, Edward R. Political Control of the Economy. Princeton, N.J.:
Princeton University Press, 1978. Argues that there is a political
business cycle caused by politicians trying to stimulate the
economy just before an election.