16.5 Budgeting and tax policy  (Page 2/28)

Keynesianism counters this problem by increasing government spending in ways that improve consumption. Some of the proposals Keynes suggested were payments or pension for the unemployed and retired, as well as tax incentives to encourage consumption in the middle class. His reasoning was that these individuals would be most likely to spend the money they received by purchasing more goods, which in turn would encourage production and investment. Keynes argued that the wealthy class of producers and employers had sufficient capital to meet the increased demand of consumers that government incentives would stimulate. Once consumption had increased and capital was flowing again, the government would reduce or eliminate its economic stimulus, and any money it had borrowed to create it could be repaid from higher tax revenues.

Keynesianism dominated U.S. fiscal or spending policy from the 1930s to the 1970s. By the 1970s, however, high inflation began to slow economic growth. There were a number of reasons, including higher oil prices and the costs of fighting the Vietnam War. However, some economists, such as Arthur Laffer, began to argue that the social welfare and high tax policies created in the name of Keynesianism were overstimulating the economy, creating a situation in which demand for products had outstripped investors’ willingness to increase production.

Mandatory spending vs. discretionary spending

The desire of Keynesians to create a minimal level of aggregate demand, coupled with a Depression-era preference to promote social welfare policy, led the president and Congress to develop a federal budget with spending divided into two broad categories: mandatory and discretionary (see [link] ). Of these, mandatory spending    is the larger, consisting of about $2.3 trillion of the projected 2015 budget, or roughly 57 percent of all federal expenditures.

The overwhelming portion of mandatory spending is earmarked for entitlement programs guaranteed to those who meet certain qualifications, usually based on age, income, or disability. These programs, discussed above, include Medicare and Medicaid, Social Security, and major income security programs such as unemployment insurance and SNAP. The costs of programs tied to age are relatively easy to estimate and grow largely as a function of the aging of the population. Income and disability payments are a bit more difficult to estimate. They tend to go down during periods of economic recovery and rise when the economy begins to slow down, in precisely the way Keynes suggested. A comparatively small piece of the mandatory spending pie, about 10 percent, is devoted to benefits designated for former federal employees, including military retirement and many Veterans Administration programs.