By Jennifer Nicoll Victor, Ph.D., George Mason University
The Scottish economist Adam Smith’s free-market ideas are well supported by the mathematics behind them. However, markets still don’t work perfectly all the time. There are conditions when the equilibrium is not found; a condition known as market failure. One purpose of government is to correct this market failure.
Government Intervention
The federal government uses regulation to correct for market failures. It can intervene to create public goods by forcing people to pay taxes. It can lower barriers to entry by providing economic incentives or grants to entrepreneurs. It can protect against monopolies through antitrust laws that regulate the merging of companies.
It can correct for negative externalities by regulating industrial by-products. And, government can correct for asymmetric information through things like transparency laws and product labeling.
However, not all government regulation is aimed at correcting market failures. Sometimes, government engages in regulations to achieve socially desirable goals.
The government regulation can be separated into two categories: economic and social. Economic regulation is typically for correcting market failures. These regulations are often created to help correct the areas where the free-market has broken down.
Social regulations, on the other hand, are not about the free-market and have nothing to do with efficiency; rather, many social regulations are in place to help society achieve socially desirable goals.
This is a transcript from the video series Understanding the US Government. Watch it now, on Wondrium.
Toolkits of the Government
Government has two main toolkits to manage the economy: fiscal policy and monetary policy.
Fiscal policy refers to the taxing and spending policies created by Congress and the president. Monetary policy refers to controlling the overall supply of money. This is done by the Federal Reserve System, an independent government entity.
Fiscal policy is controlled primarily by Congress with some involvement from the president. They really only have two levers to pull to affect fiscal policy: government spending and taxation.
Federal Budget: Process
Government expenditures begin with the federal budget process. The federal budget is produced in an annual process that begins in the executive branch with the Office of Management and Budget. The OMB collects requests from all of the various federally-funded cabinet agencies and departments, and then works in conjunction with the president’s policy priorities to produce a proposed budget of federal expenditures. Every year, this proposed presidential budget is delivered to Congress in February.
Each chamber of Congress has a special committee whose sole job is to manage this request. These committees are known as the House Budget Committee and the Senate Budget Committee. The congressional budget committees then negotiate within their committees and across the chambers to come to an agreement on the federal budget.
Once the budget is agreed upon, Congress then begins the process of appropriating the money for spending. Each federal cabinet department has its own appropriations bill that Congress aims to approve. These bills are regular laws and can be signed or vetoed by the president.
Learn more about how the vast systems of the federal government operate.
Continuing Resolution
Every year, the federal government begins its new logistical fiscal year on October 1. That means all of the appropriations bills need to be passed before then.
If the appropriations bills are not passed, then typically Congress will put into place a stop-gap measure known as a continuing resolution, often referred to as a CR.
A continuing resolution keeps agencies funded at the prior year’s levels until new appropriations are signed into law. In cases where Congress and the president are unable to agree on appropriations, and where Congress is unable to come to agreements on a continuing resolution, the government experiences a complete or partial shutdown.
A government shutdown means that all federal agencies do not have the legal authorization to spend any money. Government shutdowns tend to be highly disruptive and very expensive.
Usually, continuing resolutions are sufficient to prevent shutdowns. But continuing resolutions are laws that must be adopted by the House and Senate and signed by the president. They always come with a fixed expiration date, placing lawmakers in a need-to-act situation in order to keep the federal government running.
Learn more about the “principal-agent problem”.
Government Expenses
About 60% of the federal government’s money is spent on mandatory spending. That means, it is money that the federal government is committed to spending by law and it is unaffected by the annual appropriations process. The main categories of mandatory spending are for Social Security, Medicare, and Medicaid.
The remaining 40% is for discretionary spending and these expenditures are affected by annual changes in federal spending. About half of discretionary spending is for defense spending, and the other half is for all the other discretionary categories, including veterans’ benefits, federal transportation money for highways, bridges and dams, science and medical research, international aid, and federal government retirement benefits, among many other items.
Government’s Revenue and Deficit
Annual income taxes make up close to half of the federal government’s annual revenue. Another third of federal revenue comes from payroll taxes. These are the Social Security and Medicare taxes that are automatically deducted from most workers’ regular paychecks. The remaining 20% or so is from corporate income taxes, estate taxes, excise taxes on goods and commodities, and so forth.
When the federal government spends more in outlays than it takes in with revenue, the federal government runs a deficit. Most economists agree that it’s not overly problematic to run deficits, particularly in times of economic and military crises, or other unusual circumstances. Instead, many economists look to the ratio of total government debt to the gross domestic product, or GDP, to ascertain the overall economic health of a country.
Common Questions about Economic Policies of the US Federal Government
The government regulation can be separated into two categories: economic and social. Economic regulation is typically for correcting market failures. Social regulations, on the other hand, are in place to help society achieve socially desirable goals.
Fiscal policy refers to the taxing and spending policies created by Congress and the president. Monetary policy refers to controlling the overall supply of money. This is done by the Federal Reserve System, an independent government entity.
Annual income taxes make up close to half of the federal government’s annual revenue. Another third of federal revenue comes from payroll taxes. The remaining 20% or so is from corporate income taxes, estate taxes, excise taxes on goods and commodities, and so forth.
