c hapter 15 financing government: taxes and debt

CChapter 15hapter 15

Financing Government: Taxes and Debt

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Economic PrinciplesEconomic Principles

• Commandeering Resources• Is resources managed by the government.

• Commandeering Money (Taxes)

• It taxes people pay out of there paycheck.

• Regressive, Proportional, and Progressive Tax Structures

• Taxes that help keep America running.

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Economic PrinciplesEconomic Principles

• Social Security Taxes• A tax paid for the senior citizens of America

• Government Securities and Public Debt

• Government securities is police and other securities. Public Debt id money owed by the people in America.

• Internally and Externally Financing the Debt

• It debt paid by the people in the U.S.A and money paid by private companies

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EXHIBIT 1 PRODUCTION POSSIBILITIES CURVE

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Exhibit 1: Production Exhibit 1: Production Possibilities CurvePossibilities Curve

What is the opportunity cost of producing the first aircraft in Exhibit 1?

• The opportunity cost of producing the first aircraft is 500 houses.

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Commandeering Commandeering ResourcesResources

What is the most direct method available for a government to acquire resources?

• The most direct method is to commandeer resources.

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• This is how the pharaohs built the pyramids, and how governments built roads during the Middle Ages.

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• The military draft is a modern form of commandeering resources for the military.

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The Tax SystemThe Tax System

How is the tax system related to commandeering resources?

• The tax system commandeers money, not resources. Remember that resources are land, labor, capital, and entrepreneurship.

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Vocabulary Vocabulary

Poll tax:

A tax of a specific absolute sum levied on every person or every household.

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Regressive income tax:

A tax whose impact varies inversely with the income of the person taxed. Poor people have a higher percentage of their income taxed than do rich people.

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There’s More Than One There’s More Than One Way to Levy TaxesWay to Levy Taxes

1. What is an example of a regressive income tax?

• One example is a poll tax.

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1. What is an example of a regressive income tax?

• Another example is a tax on consumption, such as a sales tax. Since poor people spend all of their income on consumption, while rich people save a portion of their income, a consumption tax is regressive.

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Proportional income tax:

A tax that is a fixed percentage of income, regardless of the level of income.

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2. What is an example of a proportionate income tax?

• A flat-rate tax on personal income.

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Progressive income tax:

A tax whose rate varies directly with the income of the person being taxed. Rich people pay a higher tax rate—a larger percentage of their income is taxed—than do poor people.

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3. What is an example of a progressive income tax?

• The current system of federal income taxation is progressive.

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Corporate income tax:

A tax levied on a corporation’s income before dividends are distributed to stockholders.

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Are We Really Paying Are We Really Paying High Taxes?High Taxes?

True or false: Taxes as a percentage of GDP are higher in the U.S. than in any other rich industrialized country.

• False.

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True or false: Taxes as a percentage of GDP are higher in the U.S. than in any other rich industrialized country?

• As of 1994, tax revenues in the U.S. were 27.6 percent of GDP.

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True or false: Taxes as a percentage of GDP are higher in the U.S. than in any other rich industrialized country?

• In comparison, 1994 tax revenues as a percentage of GDP were 34.1 in the United Kingdom, 36.1 in Canada, 39.3 in Germany, and 44.1 in France.

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Property tax:

A tax levied on the value of physical assets such as land, or financial assets such as stocks and bonds.

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VocabularyVocabulary

Unit tax:

A fixed tax in the form of cents or dollars per unit, levied on a good or service.

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Sales tax:

A tax levied in the form of a specific percentage of the value of the good or service.

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Customs duty:

A sales tax applied to a foreign good or service.

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Excise tax:

Any tax levied on a good or service, such as a unit tax, a sales tax, or a customs duty.

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4. Complete the following sentence:

All excise taxes are ______.

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4. Complete the following sentence:

All excise taxes are regressive.

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5. Which of the following is a unit tax?

a. A 7% tax on gasoline sales.

b. A $10 tax on fishing rods.

c. A 20% flat tax on income.

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5. Which of the following is a unit tax?

b. A $10 tax on fishing rods.

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6. True or false: In any given year, Social Security taxes collected by the government equal the Social Security payments that the government makes.

• False. During the late-1990s the government gathered more Social Security taxes than were paid to beneficiaries.

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EXHIBIT 2 2000 TAX RATE SCHEDULE FOR MARRIED PERSONS FILING JOINTLY

Source: Internal Revenue Service, Instructions for Form 1040 (Washington, D.C.: Department of the Treasury, 2000), p. 7.

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Exhibit 2: 2000 Tax Rate Exhibit 2: 2000 Tax Rate Schedule for Married Persons Schedule for Married Persons Filing JointlyFiling Jointly

Suppose that a married couple filing jointly had $100,000 in taxable income. According to Exhibit 2, how much federal income tax must this couple pay?

• On the first $43,850 they pay 15%, which equals $6,577.50.

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• On the next $56,150 they pay 28%, which equals $15,722.

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• Thus the married couple pays a total of $(6,577.50 + 15,722) = $22,299.50.

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EXHIBIT 3 FEDERAL, STATE, AND LOCAL GOVERNMENT REVENUES: 2000 ($ BILLIONS)

Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, December 2000).

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Exhibit 3: Federal, State, and Exhibit 3: Federal, State, and Local Government Revenues: Local Government Revenues: 2000 ($Billions)2000 ($Billions)

Complete the sentence:

______ taxes are the largest single source of combined government tax revenues.

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Exhibit 3: Federal, State, and Exhibit 3: Federal, State, and Local Government Revenues: Local Government Revenues: 2000 ($Billions)2000 ($Billions)

Complete the sentence:

Income taxes are the largest single source of combined government tax revenues.

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EXHIBIT 4 THE FEDERAL GOVERNMENT’S SURPLUSES AND DEFICITS: 1970–2000 ($ BILLIONS)

Source: Economic Report of the President, 1997 (Washington, D.C.: U.S. Government Printing Office, 1997), p. 394, and Bureau of Economic Analysis, “Overview of the Economy.” 2000.

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Exhibit 4: Receipts, Spending, and Exhibit 4: Receipts, Spending, and Surplus/Deficits for Total and Federal Surplus/Deficits for Total and Federal Governments: 1970-2000 ($Billions)Governments: 1970-2000 ($Billions)

True or false: The federal government ran a budget surplus during the years between 1970 and 1995.

• False. The federal government ran a budget deficit during that time period.

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Public debt:

The total value of government securities—Treasury bills, notes, and bonds—held by individuals, businesses, other government agencies, and the Federal Reserve.

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EXHIBIT 5 OWNERSHIP OF THE U.S. PUBLIC DEBT: 2000 (PERCENTAGE OF TOTAL)

* Savings and loan associations, nonprofit institutions, credit unions, mutual savings banks, corporate pension trust funds, certain U.S. Treasury deposit accounts, and federally sponsored agencies.Source: Federal Reserve Bulletin (Washington, D.C., January 2001), p. A27.

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Exhibit 5: Ownership of the U.S. Public Exhibit 5: Ownership of the U.S. Public Debt: 2000 (Percentage of Total)Debt: 2000 (Percentage of Total)

Which of the following correctly identifies the top two owners of the U.S. public debt:

a. The Federal Reserve and insurance companies.

b. Federal agencies and trust funds, and foreigners.

c. Commercial banks and individual U.S. citizens.

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Exhibit 5: Ownership of the U.S. Public Exhibit 5: Ownership of the U.S. Public Debt: 2000 (Percentage of Total)Debt: 2000 (Percentage of Total)

Which of the following correctly identifies the top two owners of the U.S. public debt:

b. Federal agencies and trust funds, and foreigners.

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Financing Government Financing Government Sending Through DebtSending Through Debt

Which form of federal government debt is sold in denominations as low as $1000 and carry maturities of 2 to 10 years?

•U.S. Treasury notes.

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Tracking Government Tracking Government DebtDebtWhat caused gross federal debt to more than double between the early 1980s and the early 1990s?

• Tax cuts in 1981 and again in 1986.

• Rising government spending in the 1980s.

• Recessions in the early 1980s and again in the early 1990s.

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EXHIBIT 6A THE FEDERAL DEBT

Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).

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EXHIBIT 6B THE FEDERAL DEBT

Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).

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Exhibit 6: The Federal Exhibit 6: The Federal DebtDebt

1. During what time period did the gross federal debt grow most rapidly?

• During the period between approximately 1980 and 2000.

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2. Based on the data in panel b of Exhibit 6, in what year was federal debt as a percentage of GDP the largest?

• 1945. Spending on the war effort caused federal debt to be 125 percent of GDP.

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3. True or false: Gross federal debt as a percentage of GDP has increased sharply during the 1990s.

• False. Gross federal debt as a percentage of GDP flattened out and then declined in the 1990s.

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4. Compare panels a and b in Exhibit 6. What caused debt as a percentage of GDP to flatten out and then decline in the 1990s?

• Panel a shows that the gross federal debt increased through 1996.

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• In order for debt as a percentage of GDP to flatten out when debt is still growing, GDP must grow as fast as debt.

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• In the late-1990s gross federal debt actually began to decline.

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EXHIBIT 7 GROSS PUBLIC DEBT AS A PERCENT OF GDP FOR SELECTED ECONOMIES: 1998

Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000), p. 847.

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Hatred of Tax Collection is the Hatred of Tax Collection is the Way of the WorldWay of the World

In which of the following countries do tax collectors wear commando uniforms and carry weapons:

a. Sweden.

b. France.

c. Russia.

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Hatred of Tax Collection is the Hatred of Tax Collection is the Way of the WorldWay of the World

In which of the following countries do tax collectors wear commando uniforms and carry weapons:

c. Russia.

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Does Debt Endanger Future Does Debt Endanger Future Generations?Generations?

In one sense the answer is no. While the interest on future government debt must be paid by taxing the future economy, people in the future who own government bonds receive that interest as income.

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In another sense the answer is yes. For example, if future bondholders are rich, then the rich receive the interest income while the poor only bear the burden of higher taxes.

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In addition, increased government debt purchased by the Fed will increase the money supply, which can be inflationary.

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Another problem with increased government debt is that it tends to crowd out private investment, which slows the rate of economic growth.

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External debt:

Public debt held by foreigners.

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Recall from Exhibit 5 that foreigners are a major owner of U.S. public debt. In this case, future generations of U.S. citizens bear the burden of higher taxes to pay the interest that flows to foreigners.

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Are Deficits and Debt Are Deficits and Debt Inevitable?Inevitable?

What was the impact of the Reagan tax agenda in the 1980s on the federal budget deficit?

• Supply-side advocates convinced Reagan that cutting tax rates would cause GDP to grow so much that tax revenues would actually increase.

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• Supply-side expectations notwithstanding, the tax reforms did not do much to increase tax revenues during the 1980s. At the same time, government spending continued to grow.

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• The combination of tax cuts and government spending growth produced in the 1980s the largest annual budget deficits in the history of the United States.

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The combination of the Clinton presidency, the Republican Congress, and sustained economic growth eliminated budget deficits by the late-1990s.

Chapter 15

Questions

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Chapter Questions

1.If the Government wants to build a highway, why doesn’t it just command the necessary land, labor and capital to build the highway?

Answer

It would be extremely discriminatory.The performance would be relatively low since those who were commandeered would have little incentive to work carefully.

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Chapter Questions

2. What is the poll tax? Why would governments sometimes favor such a tax? Does the tax affect rich people and poor people alike?

Answer

Its a fixed amount of tax that every taxed person pays the government.It an easy tax to order people to pay. No it makes poor pay more on tax than the rich.

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Chapter Questions

3. What is the fundamental difference between regressive, proportional, and progressive tax structures?

Answer

The fundamental difference between the three taxes is the tax rate of all three of them.

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Chapter Questions

4. How does an excise tax differ from an income tax?

Answer

An excise tax is a per unit tax that is collected on a unit of each good or service sold.An income tax takes a specific percentage of a person’s income.

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Chapter Questions

5. What is the federal government’s most important source of tax revenue? What are the states and local governments’ most important sources of tax revenue?

Answer

The federal government’s most important source of tax is personal tax,corporate income tax, and social security contribution.

The states and local government’s most important source of tax revenue is sales,excise tax,property tax and income.

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Chapter Questions

6. What are Treasury Securities? Who owns them?

AnswerTreasury Securities are IOUs issued by the federal government’s Departments of the Treasury .The federal agencies hold the largest share of securities.Other large holders are states and local government and foreigners. Also commercial banks and individuals hold much smaller shares.

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Chapter Questions

7. What is the relationship between Treasury securities and the public debt?

Answer

The public debt is the sum of all the outstanding Treasury securities.

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Chapter Questions

8. What is the relationship between the public debt and the debt-to-go GDP ratio? How does the U.S. debt ratio compare to the ratios in other democratic market economies?

Answer

The relationship between public debt and debt-to-go GDP ratio is public debt increases substantially since mid-1970s and debt-to-go GDP ratio has fell until early 1980s. It has increases from less than $1 trillion to more than $5 trillion in 1995, and I other countries it decreases or remains constant.

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Chapter Questions

9. Explain why some economist believe the burden of a public debt cannot be shifted onto future generations.

AnswerThe reason the public debt cannot be shifted onto future generation is, we will inherit the securities and receive each year the annual interest of our generation. We will also inherit the tax obligation to pay the interest payments. Meaning that the impact on the future generation will be neutral.

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Chapter Questions

10. Some economist believe that the public debt may be detrimental to the economy’s growth. Explain.

Answer

Their will be less private investment because the government may force the interest rate up making more private firms to finance their investment project. There is going to be a crowding out of private investment.

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Chapter Questions

11. How does an externally help public debt differ from an internally help public debt?

AnswerIf the debt publicly funded for future generations

will remain neutral, if the debt funded externally there will be more tax on the future generation.

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Activities

41 42 Unit 4 Multiple Choice Questions, Short Free-

Response Questions, Long Free-Response Questions

c hapter 15 financing government: taxes and debt

Documents

proportionate income

tax system

consumption tax

sales tax

debt slide

vocabulary poll tax

personal income

corporations income