Fiscal policy's evolution in the United States

Evolution of U.S. Fiscal Policy

Before the United Stated entered the Great Depression, the government's approach to the economy was laissez faire, which means it did not intervene in business affairs. Taxes were typically paid only by the very richest individuals and companies, and were therefore often referred to as class or mass taxes under an "Ability to Pay" arrangement (Waltman 1985).

British economist John Maynard Keynes (father of Keynesian economics) believed the best way to encourage fiscal stability for the nation was to leverage government spending to promote consumption and investing. He believed that government could influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This in turn would decrease inflation increase employment and keep the overall value of money constant. The logic of "Keynesian" economics became widely accepted. Economists increasingly came to believe that government could and should effectively manage the capitalist economy (Dyson 2010).

The economy evolved between WWI and WWII. World War II led to dramatic changes in ideas about taxation. The costs of fighting the war were huge and it was clear that no one would be able to avoid massive increases in their personal tax burden. Also, more people were moving away from agriculture and into industry. More incomes were being paid in cash by employers via weekly paychecks. A new political economy had opened up and ushered in new ideas about taxation (Weber and Wildavsky 1986).

Unions and new working and middle class parties were stirred into action. Their political representatives increasingly demanded that taxes be used as instruments to change the unfair distribution of income and wealth brought about by capitalism. New fiscal policies emerged due to the changing structure of capitalism and these political demands placed upon policy makers. There were newer sources of revenue which meant new levels of government involvement in the economy. This ultimately shaped what policy makers and interest group activists understood to be possible and desirable. Eventually, it was determined necessary for government to take a more active role in regulating unemployment, business cycles, inflation and the cost of money (Waltman 1985). Tax policies were aimed at being more efficient, universal and fair, although they were not always successful in accomplishing these goals (Weber and Wildavsky 1986).

By the 1960's and 70's, taxes were increasingly seen by political leaders as low cost solutions to virtually every problem. Massive tax expenditures (commonly referred to as loopholes) were created, but eventually became viewed as giveaways to the rich, ineffective policy tools, costly to the U.S. Treasury, and outside normal public scrutiny (Dyson 2010). Tax incentives were often misused, and policymakers came to believe that it would be better to have few, if any, tax expenditures than to have a tax system plagued by loopholes designed for the politically powerful.