How should the U.S. government carry out its economic roles?
Before the onset of the Great Depression in the 1930s, the federal government generally followed a hands-off policy toward the economy. Except for times of national emergency, such as the Civil War and World War I, the role of the government in the lives of ordinary people remained small. Then came the stock market crash of 1929, which plunged the nation into the worst economic crisis in its history.
The 1929 stock market crash triggered a financial crisis that forced thousands of banks to go out of business. Millions of depositors lost their savings. Consumers slowed their spending, and firms cut back production or shut down altogether. The economy took a nosedive, and the Great Depression began.
At first the government did little, assuming that the economy would stabilize on its own. But as the economy worsened, many people looked to the government for help. In 1932, Franklin D. Roosevelt won the presidency by promising a different approach-a New Deal for the American people.
The New Deal greatly expanded the federal government’s role in the economy. It created dozens of new programs and agencies aimed at reforming the banking system, helping businesses, and providing jobs. Most New Deal agencies did not outlast the Great Depression. However, the huge federal bureaucracy spawned by the New Deal lived on.
The Depression ended when World War II began. But the federal government did not return to its traditional hands-off role. Instead, it took charge of the wartime economy, overseeing industries as they converted from consumer to military production. To pay for the war effort, the government also sharply increased individual and corporate income taxes.
When the war ended, the federal government ended its supervision of industrial production. But many Americans feared a return to hard times and widespread unemployment. Congress responded to those fears by passing the Employment Act of 1946. This act clearly stated an important role for government in stabilizing the economy:
This act gave the federal government an active role in managing the nation’s economy. To carry out that role, the act established the Council of Economic Advisers. This council helps the president formulate sound economic policies. The act also established a Joint Economic Committee that includes members from both houses of Congress. The committee’s job is to review the state of the economy and advise Congress on economic policies.
Americans clearly benefit from economic stability. In a stable economy, jobs are secure, goods and services are readily available, and prices are predictable. Producers, consumers, and investors can plan for the future without having to worry about sudden upheavals in the nation’s economy.
The government promotes economic stability in part by creating a widely accepted currency – the dollar – that maintains its value. The government also promotes stability by stimulating business activity during economic slowdowns. It does this through tax incentives, which encourage businesses to invest in new capital equipment, and through tax rebates, which encourage consumers to spend more money.
In 2008. for example. difficulties in the housing market sent the economy into a tailspin. Reacting to the uncertainty, consumers cut back on spending. To generate more spending. Congress enacted an economic stimulus package – legislation specifically designed to stimulate business activity. The package called on the Internal Revenue Service to mail checks of $600 or more, depending on family size, to 130 million households. The nation’s leaders encouraged Americans to spend their stimulus checks on consumer goods and services.
Markets allocate resources efficiently, as Adam Smith noted when he described the invisible hand of the marketplace. But Smith did not conclude that markets allocate resources fairly. Some people, for example, end up with vastly higher incomes than others.
Every year. the U.S. Census Bureau charts the distribution of income in the United States. It starts by ranking households on the basis of their incomes. Then it divides the entire list of households into five equal parts, called quintiles. The bottom quintile contains the lowest incomes, and the top quintile contains the highest incomes.
The Census Bureau also calculates the percent of total income each quintile received. In 2012, for example, the bottom fifth received 3.2 percent of all income, while the top fifth received 51.0 percent. Clearly, income is not distributed equally in the United States.
Another tool for measuring the distribution of income is the poverty rate. This rate is the percentage of households whose incomes fall below a certain dollar amount determined by the Census Bureau. That dollar amount, called the poverty threshold, is the estimated minimum income needed to support a family.
The poverty threshold varies depending on family size and composition. For example, a family with two adults and one child is expected to live on less income than a family with one adult and four children.
The government considers families to be poor if their incomes fall below their poverty threshold. In 2012, by this measure, more than one family in ten lived in poverty. Altogether, the members of those families represented 15.0 percent of the U.S. population. The poverty rate, then, was 15.0 percent in 2012.
Poverty rates vary depending on such factors as age, race, ethnicity, and family composition. It is also worth noting that the Census Bureau’s rankings vary from year to year. Just because a family is in the bottom fifth this year does not mean it will stay there. A hallmark of American society is economic mobility. People who work hard are usually able to move up the economic ladder. As a result, relatively few families remain in poverty for the long term.
For much of 0our nation’s history, the poor relied mainly on friends, family, and private charities to provide for their basic needs. Local communities sometimes established poor houses and poor farms to house the very poor. Otherwise, the poor were left to fend for themselves as best they could.
Then came the Great Depression. With it came an expanded role for government in the economy. New Deal programs aided millions of Americans. The Social Security Act, for example, did much to reduce poverty among disabled and older Americans. However, these programs did not lift every family out of poverty.
During the 1960s, the federal government launched a War on Poverty to help the nation’s neediest families. Congress devised dozens of antipoverty programs that together created an economic safety net. Those programs had some success. The poverty rate for families dropped from 18.1 percent in 1960 to 10.1 percent in 1970.
Since the 1960s, most antipoverty programs have involved some form of income redistribution, a policy designed to reduce the gap between the rich and the poor. This policy works by taxing wealthier members of a society and then distributing that money to the poor to achieve greater income equality. Redistribution takes a number of forms, including those described here.
Welfare. When most people talk about welfare, they are referring to Temporary Assistance for Needy Families. The TANF program, funded largely by the federal government but run by the states, provides benefits, services, and work opportunities to needy families. In some states, TANF benefits come in the form of cash transfers, or direct payments of cash from the government to individuals.
Other TANF benefits are distributed in the form of goods or vouchers, rather than cash. These in-kind transfers include food stamps, public housing, school lunches, and Medicaid. For example, when a person receives health services through the Medicaid program, the government pays the health care provider. No cash goes to the Medicaid recipient.
Earned income tax credit. The government also helps the working poor through the Earned Income Tax Credit. Low-wage workers can claim this credit when they file their federal income tax forms. The credit is applied against whatever taxes are due. Depending on a worker’s family size and income, the credit can exceed those taxes. If it does, the worker receives a tax refund.
Unemployment insurance. Employers, through federal and state taxes, contribute to a fund that provides unemployment insurance for workers. If workers are laid off from their jobs, the state sends them payments – unemployment compensation – for a certain period of time or until they find another job. Each state administers its own unemployment insurance program, based on federal standards.
Through its antipoverty policies, the government redistributes income in a way that is intended to help the poor. Yet critics charge that these policies have had unintended negative consequences for the very people they are meant to help.
These critics worry that antipoverty programs promote dependence on the government and reduce people’s incentive to become self-sufficient. TANF, food stamps, Medicaid, and the Earned Income Tax Credit are what economists call means-tested programs – that is, they are tied to family income. The more a family earns, the fewer benefits that family can claim. For this reason, recipients of government assistance may have little incentive to get a job and earn money. If their incomes exceed the poverty threshold, they will lose their government benefits.
For welfare recipients with minimal skills and education, getting a job may indeed make them worse off. This is because the kinds of jobs available to low-skill workers usually pay minimum wage and have no benefits. Consider a single mother with less than a high school education. She leaves welfare and takes a low-paying job with no health insurance benefits. She still must struggle to support her children on her low wages. But now, because she is working, she and her children are ineligible for government-provided health services.
Policymakers have developed a variety of proposals to address such problems. One is to provide job training and education for welfare recipients to increase their human capital and help them become self-sufficient. Another is to raise the cap on certain means-tested programs, so that benefits are gradually reduced as income rises. Both of these proposals would lead to higher costs and, most likely, higher taxes to pay for those costs.
A third possible solution is public service employment. As it did during the Great Depression, the government could pay the unemployed to perform useful work. However, this might cause a flood of workers to shift from private jobs to more secure government jobs – at great expense to taxpayers.
As always, when resources are limited, whatever choices a government makes will result in tradeoffs. You may not be aware of these tradeoffs now, but at some point you will be. Why? Because government programs are funded by tax dollars, and once you enter the world of work, you will become a taxpayer. Later on, you will learn more about taxes and how they are used to support the many roles government plays in our lives.