Chapter 17 Taxation, Budgetary Policy, and the National Debt © 2001 South-Western College Publishing

2 Characteristics of a Good Tax 4 Justifiable reason 4 Equitable to taxpayers 4 Certitude about the amount of tax and the taxpayer’s obligation 4 Convenient to levy and collect 4 Economical as to cost of collection

3 Equity or Fairness in Taxation 4 Cost-of-Service Theory: consumers should contribute to the cost of government in proportion to cost of services received 4 Benefit-Received Theory: consumers should contribute in proportion to benefits received from government services 4 Ability-to-Pay Theory: consumers should contribute taxes consistent with their ability to pay

4 Equity in Taxation (cont.) 4 Proportional Standard: all taxes should be proportional to wealth or income 4 Equality-of-Sacrifice Doctrine: based on the diminishing marginal utility of income

5 Tax Rate Structure 4 Tax Base: value of the object upon which the tax is levied 4 Tax Rate: percentage by which the tax base is multiplied in calculating the total tax to be paid –Proportional Rate: remains the same regardless of the size of the base –Progressive Rate: increases as the size of the base increases –Regressive Rate: decreases as the size of the base increases

6 The Tax Burden 4 Does not always fall on the person/firm paying the tax 4 Some can be shifted –DIRECT TAX such as income tax cannot be shifted –INDIRECT TAX such as excise tax on liquor can be shifted

7 Tax Shifting 4 Tax Shifting - passing the tax burden from one taxpayer to another 4 Impact of a tax - the financial burden entailed in paying a tax 4 Incidence of a tax - the point at which the burden of the tax ultimately rests 4 Effect of a tax - economic consequence of paying the tax

8 The Federal Government Dollar Individual Income Taxes 48% Social Insurance Receipts 34% Corporate Income Taxes 10% Excise Taxes 4% Other 4% Non-Defense Discretionary 17% Net Interest 11% National Defense 15% Social Security 22% Medicare 11% Reserve Pending Social Security Reform 6% Medicaid 6% Other Means- Tested Entitlements 6% Remaining Entitlements 6% Where it comes from…Where it goes...

9 Major Tax Proposals 4 Flat Tax - a single tax rate of between 15% and 20% 4 Consumption Tax - exempts savings from taxation 4 Value-Added Tax - collects taxes at each stage of production; is passed from the producer to the consumer 4 National Sales Tax - highly regressive; collected on the final sales of goods and services, paid for by consumers

10 Purposes of Taxation 4 Cover cost of government 4 Redistribute income and wealth 4 Economic stabilization

11 Budgetary Policy Types of Budgets: –Balanced budget - has a neutral effect on the economy –Deficit budget - government spends more than it receives in taxes; increases total income and output, or increases price level; also known as fiscal stimulus –Surplus budget - government spends less than it receives in taxes; results in net decrease in aggregate expenditure; also known as fiscal drag

12 Budget as a Stabilizer 4 Surplus budget helps prevent inflation during a peak period 4 Deficit budget helps offset unemployment during a trough period 4 Goal is to balance the budget over a business cycle, rather than annually

13 The Budget Used as an Anticyclical Device GDP Years Surplus Budget Deficit Budget Surplus Budget Possible Modification of Business Cycle

14 Full-Employment Balanced Budget According to this concept, the actual budget does not need to be balanced, but tax rates and government spending should be set to balance the budget at the full-employment level of income and output

15 Problems of the National Debt 4 Misunderstanding about Bankruptcy 4 Redistribution of Income 4 Burden of the Debt - effects on the total economy and on consumers 4 The Money Supply and the Debt 4 Size of the Debt 4 Refunding the Debt 4 Burden of Interest Payments 4 Productivity of the Debt

16 Total National Debt of the U.S., (Selected Fiscal Years) Billions of Dollars Fiscal Years

17 Debt Held by the Public as % of GDP, Fiscal Years Percentage of GDP Fiscal Year

18 The Road to Budget Surplus 4 Debt Reduction –Balanced Budget and Emergency Deficit Control Act of 1985 (The Gramm-Rudman- Hollings Act) –Budget Reduction Act of 1990 –The Revenue Reconciliation Act of 1993 –The Balanced Budget Act of The Age of Surplus –Reduced discretionary spending –Soaring tax revenues

19 International Comparison of Debt: Gross Public Debt as % of GDP, 1999 (selected countries) Percentage of GDP Countri es Italy BelgiumJapanCanadaSpainSwedenFrance NetherlandsGermany U. S.U. K. Australia 118% 113% 107% 86% 73% 68% 67% 63% 62% 55% 27%