Chapter 14 Taxes and Government Spending

Taxes Tax – Financial charges imposed on individuals and businesses by a government Purposes of taxes To provide public goods that the market does not provide (e.g., military, roads, libraries) Income redistribution (e.g., assistance to the poor, social security)

Classifications of Taxes Progressive Taxes – charge the rich a higher % of income than the poor Example – Income taxes in the U.S.

Income Tax Rates for Single Filer (2009) 10% on income between $0 and $8,350 15% on the income between $8,350 and $33,950; plus $835 25% on the income between $33,950 and $82,250; plus $4,675 28% on the income between $82,250 and $171,550; plus $16,750 33% on the income between $171,550 and $372,950; plus $41,754 35% on the income over $372,950; plus $108,216

Classifications of Taxes Proportional Taxes – charge all people an equal % of income Example – Proposed “Flat Tax” All taxpayers would pay around 20% regardless of income

Classifications of Taxes Regressive Taxes – Charge the poor a higher % of income than the rich Example – Sales Taxes, FICA Payroll Tax

How Sales Taxes are Regressive Person #1 Income of $45,000 Saves $3,000, spends $42,000 Taxed 10% on $42,000, or $4,200 $4,200 / $45,000 = 9.3% Person #2 Income of $450,000 Saves $100,000, spends $350,000 Taxed 10% on $350,000, or $35,000 $35,000 / $450,000 = 7.8%

Government Spending Fiscal Policy – government policies involving collecting tax revenue and deciding how to spend it Executive branch submits a proposed budget to Congress Congress makes revisions and votes on the final budget President has choice to sign or veto the budget

Government Spending What is the budget (approx. $3.5 Trillion) currently spent on? Health – 22% Includes Medicare, Medicaid, Safety Inspections, Veterans Benefits Social Security – 19% Defense – 19% Income Security – 15% Includes Unemployment Assistance, Housing Assistance, Food Stamps

Government Spending What is the budget (approx. $3.5 Trillion) currently spent on? Interest on the Debt – 6% Other Programs – 15% Includes Homeland Security, Science and Technological Research, Agriculture Subsidies, many more Education – 2% Environmental Protection – 1% International Affairs – 1% Includes assistance to foreign countries

Categories of Federal Spending Mandatory Spending – Congress has no choice on changing funding amounts Includes entitlements – programs that all Americans who reach a certain status are eligible for, regardless of high or low income Ex. – Social Security, Medicare Discretionary Spending – Can be cut or expanded by Congress Includes “means-tested” programs – those that only low income individuals qualify for Ex. – Food stamps, TANF, Housing assistance

Government Spending Possible outcomes of budgets Surplus – more tax revenue than government spends Deficit – more spending than tax revenue Money must be borrowed to make up the difference (government sells bonds) Creates debt – money that has not been repaid over time, plus interest

Deficit Projections

Who is the Money Owed To?

Perspectives on Debt and Deficit Deficit Hawks – opposed to deficit spending Classical economists like Von Hayek and Friedman Believe deficits are unsustainable, pass costs on that will hurt future economic growth, raise interest rates Deficit Doves – believe deficit spending can stimulate economic growth Keynesian economists See no harm in short term deficits, as long as they are used wisely, they could produce future growth that exceeds the present deficit

Expansionary vs. Contractionary Fiscal Policy Just like monetary policy can expand or contract the economy, so can fiscal policy Expansionary policy – to grow GDP and cut unemployment, but could cause inflation Cut taxes on individuals Spend more on benefits and other programs Contractionary policy – to cut inflation, but could lead to slowing growth and raising the unemployment rate Raise taxes on individuals Cut government spending

Perspectives on the “Best” Fiscal Policy Classical Economists (like Von Hayek, Friedman) Government should not interfere in the economy, to establish equilibrium prices and quantities Demand-Side (Keynesian) Economists Government should cut taxes on individuals, spend money to benefit people in order to raise demand and grow the economy Supply-Side Economists (Reaganomics) Government should cut taxes and regulations on businesses to raise supply and grow the economy