Chapter 4 The U.S. Economy: Private and Public Sectors McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives U.S. household and business facts The corporate form of business organization Principle agent problem The economic role of government Government spending and sources of revenue 4-2

Household Income Functional distribution of income Types of income Wage, rent, interest, profit Personal distribution of income Division among households by quintile 4-3

Functional Distribution of Income 2007 National Income Received (Percent) 0 10 20 30 40 50 60 70 Wages & Salaries 71% 1% Rents Income By Function Performed 5% Interest Proprietor’s Income 9% Corporate Profits 14% Source: Bureau of Economic Analysis 4-4

Personal Distribution of Income 2006 Personal Income Received (Percent) 0 10 20 30 40 50 60 Lowest 20% 3.4% Second 20% 8.6% Income Group (Households) Middle 20% 14.5% Fourth 20% 22.9% Highest 20% 50.5% Source: Bureau of the Census 4-5

Households as Spenders Uses of household income? Personal taxes (13%) Personal saving (1%) Personal consumption (86%) Durables (11%) Nondurables (29%) Services (60%) 4-6

The Business Population Plant Firm Industry Multiplant firms Vertically integrated Conglomerates 4-7

Domestic Output Sole proprietorship Partnership Corporation 20% 8% 84% Corporations 8% Partnerships Corporations 84% 72% Sole Proprietorships Partnerships 11% Sole Proprietorships 5% Percentage of Firms Percentage of Sales Source: U. S. Census Bureau 4-8

Advantages of Corporations Methods of finance Stocks Bonds Limited liability Hiring of specialists Unlimited lifetime 4-9

Principal-Agent Problem Potential disadvantage of corporations Stockholders are principals Executives are agents Conflict of interest? 4-10

The Public Sector Federal, state, and local government Role of the government in the economy? 4-11

Government’s Role Provide the legal structure Maintain competition Set the laws we live by Maintain competition Monopoly and antitrust laws Redistribute income Transfer payments Market intervention Taxation 4-12

Government’s Role Reallocating resources Market failure Negative externality Positive externality Public goods 4-13

Correcting for Externalities Negative externalities Legislation Specific taxes Positive externalities Subsidies Government provision of goods 4-14

Types of Goods Private goods Public goods Free-rider problem Rival and excludable Public goods Nonrival Nonexcludable Free-rider problem Quasi-public goods The reallocation process 4-15

Government’s Role Promoting stability A qualification Unemployment Inflation A qualification Politics Too much or too little regulation Inefficiency 4-16

The Circular Flow Revisited Resource Market Money Income Costs Input Factors Resources Expenditures Resources Goods & Services Goods & Services Businesses Government Households Net Taxes Net Taxes Expenditures Goods & Services Goods & Services Goods & Services Product Market Revenue Consumption 4-17

Government Finance Government purchases Government transfers 35 30 25 20 15 10 5 Government Transfer Payments 32% 27% 13% 5% Percentage of U.S. Output 22% 19% Government Purchases 1960 2007 4-18

Government Revenue Total Tax Revenue, Approximate Percentage of GDP, 2007 10 20 30 40 50 Sweden Denmark Finland France Italy Germany United Kingdom Canada Australia United States Japan South Korea 58 55 51 51 46 43 42 40 35 34 33 32 Source: Organization for Economic Cooperation and Development 4-19

Federal Expenditures 34% 21% 24% 9% Percentage of total expenditure ($2,731 billion), 2007 0 10 20 30 40 50 Pensions & Income Security 34% National Defense 21% Health 24% Interest on the Public Debt 9% Source: U. S. Office of Management and Budget 4-20

Federal Tax Revenues 45% 34% 14% 3% 4% Sources of total tax revenue ($2,568 billion), 2007 0 10 20 30 40 50 Personal Income Tax 45% Payroll Taxes 34% Corporate Income Taxes 14% Excise Taxes 3% All Other 4% Source: U. S. Office of Management and Budget 4-21

Personal Income Tax Progressive tax rates Marginal tax rate Brackets of income Marginal tax rate Average tax rate 4-22

PAKISTAN BUDGET 2012-13 (INCOME TAX): In 2011-2012 the  basic  exemption limit was proposed to be Rs.350,000/- and there were 17 income tax slabs. Basic exemption limit is now being raised for salaried and business Individuals  to Rs.400,000. The existing  rate slabs are proposed to be reduced from 17 to 5. Income Tax Slab Rates For Salaried Class for Financial year 2012-13 as approved by Pakistan Finance Act, 2012 : Total Taxable Income Marginal tax rate 0-400,000 0% 400,000-750,000 5% 750,000-1500,000 10% 1500,000-2000,000 15% 2000,000-2500,000 17.5% Over 2500,000 20%

Income Tax Slab Rates For Salaried Class for Financial year 2012-13 as approved by Pakistan Finance Act, 2012. Total Taxable Income Marginal tax rate Total tax on highest income in bracket Average tax rate 0-400,000 0% 400,000-750,000 5% 17500 2.3 750,000-1500,000 10% 92500 6.1 1500,000-2000,000 15% 167500 8.3 2000,000-2500,000 17.5% 255000 10.2 Over 2500,000 20% 315000 11.2 If an individual is earning 2800,000 then, average tax rate would be 11.2

Calculations 750,000-400,000= 350,000*5%= 17,500 1500,000-750,000= 750,000*10%= 75,000+17,500 =92,500 2000,000-1500,000 =500,000*15% =75,000+92,500 =167,500 2500,000-2000,000 =500,000*17.5% =87,500+167,500 =255,000 If a person is earning 2800,000 then, 2800,000-2500,000 =300,000*20% =60,000+255,000 =315,000 Average tax rate: 17500/750,000= 2.3 92,500/1500,000= 6.1 167,500/2000,000= 8.3 255,000/2500,000= 10.2 315,000/2800,000= 11.2

State Finances Primary Expenditures Education (36%) Public Welfare (28%) Health & Hospitals (7%) Highways (7%) Public Safety (4%) Other (18%) 4-26

State Finances Primary Revenues Sales & Excise Taxes (47%) Personal Income Taxes (35%) Corporate Income Taxes & License Fees (18%) 4-27

Local Finances Primary Revenues Primary Expenditures Property Taxes 73% Sales & Excise Taxes 17% Primary Expenditures Education 44% Welfare, Health & Hospitals 12% Public Safety 11% Housing, Parks, & Sewers 8% Streets & Highways 5% 4-28

Financing Social Security Demographic changes Long-run shortfall in funding Pay-as-you-go plan Trust fund withdrawals Trust fund exhausted in 2041 Benefit reductions? Tax revenue increases? 4-29

Financing Social Security Possible solutions Stock & bond investments Payroll tax increases Individually directed accounts Privately owned and managed accounts Consensus difficult 4-30

Key Terms functional distribution of income monopoly personal distribution of income durable goods nondurable goods services plant firm industry sole proprietorship partnership corporation stock bond limited liability principal-agent problem monopoly externality negative externalities positive externalities public goods free-rider problem quasi-public goods government purchases transfer payments personal income tax marginal tax rate average tax rate payroll taxes corporate income tax sales and excise taxes property taxes 4-31

The United States in the Global Economy Next Chapter Preview… The United States in the Global Economy 4-32