Lesson 5.3 Economics

The Role of Government


McGraw-Hill Education
Common Core Basics

Government’s Role in the Economy

The role of government in the US economy has expanded over the past century. The average American in the early 1900s would be astounded by the new roles that have been taken over by government.

Laissez-Faire Capitalism

Laissez-faire is a French term that means “let do” or “let be.” In economics, laissez-faire capitalism is an economic system run without government interference. The laissez-faire doctrine dominated the US economy from the early twentieth century until the start of the Great Depression in the 1930s.

The Great Depression and New Deal

The Great Depression was a severe decline in the US economy during the 1930s. In November 1932, Franklin D. Roosevelt was elected president. Assisted by a worried Congress, Roosevelt launched the New Deal in March 1933. It vastly expanded the role of government in the US economy. The New Deal included these achievements:

  • put millions of unemployed people to work in government programs such as the Civilian Conservation Corps (CCC) and Works Progress Administration (WPA)
  • created the Social Security system
  • created new regulations to monitor business practices and strengthen banks, including the Federal Deposit Insurance Corporation (FDIC) to protect bank deposits
  • created the Fair Labor Standards Act to guarantee workers a minimum wage, a 44-hour work week, and overtime pay

From 1946 through the 1980s

Immediately after World War II, Congress passed the Employment Act of 1946, which was designed to help stabilize the economy. The government would now be expected to create policies that would promote economic growth, full employment, and stable prices if the US economy faltered.

During President John F. Kennedy’s administration (1961-1963), the government cut taxes. Soon after that, President Lyndon B. Johnson (1963-1968) and Congress enacted the Great Society programs. These programs expanded aid to the needy. Medicare provided health insurance for the elderly, and Medicaid did the same for the poor.

Some attempts were made to reign in government involvement in the 1980s. During President Ronald Reagan’s administration (1981-1989), policies to eliminate business regulations and tax cuts were enacted.

From 2007 to the Present

A serious recession from 2007-2009 brought another wave of government interventions in the economy. A recession is an economic downturn in which business activity slows, unemployment rises, and investment decreases. In 2008, near the end of George W. Bush’s presidency (2001- 2009), the government provided hundreds of billions of dollars to rescue ailing financial institutions. The Bush administration also supported a large tax rebate. A tax rebate is similar to a tax refund. The goal was to bring about economic recovery by encouraging people to buy more goods.

Under the Barack Obama administration (2009-2016), hundreds of billions of additional dollars were pumped into an “economic stimulus package.” The stimulus package was intended to create jobs and to encourage economic growth.

The Four Roles of Government

One of the most important features of the US economic system is limited government. However, the role of government has expanded over time. Today government has four roles in our economy. It regulates businesses, provides public goods, promotes the well-being of the people, and stabilizes the overall economy. People generally support some government involvement in these areas. Still, there is debate about how involved the government should be in the country’s economy.

Regulating Business Activity

The government creates laws that govern businesses. For instance, laws prohibit monopolies from forming. This is to promote competition, which should provide consumers with more options and better prices.

In addition, over time the government has created numerous federal agencies to guide business behavior. The Federal Trade Commission (FTC) protects people from dishonest or misleading advertising. The Consumer Product Safety Commission (CPSC) protects consumers from dangerous products. The Securities and Exchange Commission (SEC) protects investors from investment fraud. The Occupational Safety and Health Administration (OSHA) protects workers from unsafe working conditions.

Providing Public Goods

Government at all levels-local, state, and national-provide public goods. Public goods are goods that the government provides for all people to use.

But why does government, rather than private businesses, produce public goods? The answer is that individuals and businesses are not willing to produce all the public goods needed to satisfy people. For example, a business needs highways so it can sell its products in cities across the country. But it is not willing to build the highways. In fact, other businesses also need the highways, and private citizens would use the highways for work or recreation. Over time the government recognized the need for highways. To spread the cost of these roads among all possible users, the government collected taxes to build those highways.

Promoting the Well-Being of the People

The government promotes well-being mainly through transfer payments. A transfer payment is money used to help people in need. The t~o types of transfer payments are social insurance programs and public assistance programs.

Social insurance programs give benefits to people who have made regular financial contributions to the program. The largest social insurance programs are Social Security and Medicare. Working people and their employers pay into these two programs. Upon retirement these people receive income and health benefits from the government.

Public assistance programs give benefits to people who have not made financial contributions to the program. Payments to the poor under Temporary Assistance to Needy Families (TANF) and health insurance through Medicaid are examples of public assistance programs.

Stabilizing the Economy

The government stabilizes the economy by trying to ease economic. downturns and other economic problems. Traditionally, the two main types of government policies used to stabilize the economy are fiscal policy and monetary policy.

Fiscal policy is the use of taxation and government spending to deal with economic problems. During times of recession, when business activity is slow, Congress and the president might decrease taxes and increase government spending. More money circulating in the economy creates more demand for goods, more production, and more jobs. To fight inflation (a general rise in prices), the government might increase taxes and decrease government spending.

Monetary policy is under the control of the Federal Reserve System (the Fed), the central bank of the United States. The Fed’s most important monetary tool is open-market operations. Open-market operations occur when the Fed buys or sells government securities, such as bonds. To fight recession, the Fed buys back its securities from investors. This adds cash to the economy so business activity will increase. To fight inflation, the Fed sells additional securities to investors. This removes excess cash from the system and slows the rise of prices.

Taxation: Paying for Government Programs

A tax is a mandatory, or required, payment people make to the government. Individuals and businesses pay taxes to the local, state, and federal government.

Local Taxes

Local taxes are used mainly to take care of local needs such as education and public safety. The property tax is the most important local tax because it raises the most money for towns or cities. A property tax requires people with major assets-mainly their homes-to pay a tax on these assets each year.

State Taxes

State taxes are used to take care of state and local needs such as highways, education, and the criminal justice system. Most state tax revenues come from three taxes: state income tax, state sales tax, and excise taxes. State income taxes vary. Typically, the tax consists of a percent of the worker’s wage. The state sales tax requires people who purchase certain goods to pay a percent of the purchase price as a tax. Some states exempt items such as food and medication from the sales tax so that the tax is less of a burden on• the poor. The excise tax is a tax on a specific item. Many states impose excise taxes on cigarettes, alcohol, and gasoline.

Federal Taxes

Federal taxes are used mainly to pay for major federal programs, such as national defense, Social Security benefits, and Medicare and Medicaid programs. Most federal revenues come from three taxes: the personal income tax, social insurance taxes, and corporate income tax. The personal income tax raises the most money for the federal government. It is a progressive tax, which means that people with higher incomes pay a higher percent of their income in taxes. Social insurance taxes, such as the Social Security and Medicare tax, take a percent from wage earners’ paychecks. The corporate income tax takes a portion of corporation profits.