Magruder’s American Government C H A P T E R 16 Financing Government © 2001 by Prentice Hall, Inc.

C H A P T E R 16 Financing Government SECTION 1 Taxes SECTION 2 Nontax Revenues and Borrowing SECTION 3 Spending and the Budget 1 2 3 Chapter 16

How and why does the Constitution give Congress the power to tax? S E C T I O N 1 Taxes How and why does the Constitution give Congress the power to tax? What are the most significant federal taxes collected today? Why does the Federal Government impose taxes for nonrevenue purposes? 2 3 Chapter 16 Section 1

Limits on the Power to Tax Article I, Section 8, Clause 1 of the Constitution grants Congress the power to tax. The Sixteenth Amendment gives Congress the power to levy an income tax. Limits on the Power to Tax The power to tax is also limited through the Constitution. According to the Constitution: 1. Taxes must be used for public purposes only. 2. Federal taxes must be the same in every State. 3. The government may not tax exports. 2 3 Chapter 16, Section 1

Progressive Tax vs. Regressive Tax Progressive Taxes – make individuals with a larger income spend a larger percentage of their income paying the tax. Regressive Taxes – are those which take an equal or greater percentage from those with lower incomes as opposed to those with higher incomes. Rational - Progressive taxes are defended because people with smaller incomes must spend a larger percentage of their income on basic necessities so they cannot afford to pay as much. Examples The U.S. federal income tax is a progressive tax because it charges a higher percentage rate as your income increases. The sales tax is a regressive tax because the expense represents a larger percentage of poorer individual's incomes. Source ehow.com

Corporation Income Tax Current Federal Taxes The Income Tax The income tax is the largest source of federal revenue today. The tax is also a progressive tax, that is, the higher the income and the ability to pay, the higher the tax rate. Individual Income Tax Individual income taxes regularly provide the largest source of federal revenue The tax is levied on each person’s taxable income. Corporation Income Tax Each corporation must pay a tax on its net income, that is, on the earnings above the costs of doing business. 2 3 Chapter 16, Section 1

Historical Income Tax Rates Major Tax Cuts: 1921-1922 & 1924-1925 (Harding & Coolidge), 1963-1965 (Johnson), 1981-1982 & 1986-1988 (Reagan) Major Tax Increases: 1916-1917 (Wilson), 1931-1932 (Hoover) & 1935-1936 (Roosevelt),

Historical Cooperate Tax Rates

What are Marginal Tax Rates Definition of 'Marginal Tax Rate’ The amount of tax paid on an additional dollar of income. The marginal tax rate for an individual will increase as income rises. This method of taxation aims to fairly tax individuals based upon their earnings, with low income earners being taxed at a lower rate than higher income earners. Investopedia explains 'Marginal Tax Rate’ Under a marginal tax rate, tax payers are most often divided into tax brackets or ranges, which determine which rate taxable income is taxed at. As income increases, what is earned will be taxed at a higher rate than your first dollar earned. While many believe this is the most equitable method of taxation, many others believe this discourages business investment by removing the incentive to work harder.

Marginal Tax Rates

Social Insurance Taxes There are three main types of social insurance taxes levied: OASDI The Old-Age, Survivors, and Disability program is the basic Social Security program. Medicare Medicare is health insurance for the elderly and part of the Social Security program. Unemployment Compensation The unemployment compensation program pays benefits to jobless workers and is also part of the overall Social Security program. 2 3 Chapter 16, Section 1

Other Types of Taxes 2 3 Excise Taxes Custom Duties An excise tax is a tax laid on the manufacture, sale, or consumption of goods and/or the performance of services. Custom Duties A custom duty is a tax laid on goods brought into the U.S. from abroad. Estate and Gift Taxes An estate tax is a levy imposed on the assets (estate) of one who dies. A gift tax is one imposed on the making of a gift by a living person. 2 3 Chapter 16, Section 1

Individual Income Tax vs. Payroll Tax Income taxes are withheld from an employee's wages and go into a general fund. Payroll taxes are comprised of Medicare and Social Security taxes--also withheld from an employee's paycheck. However, the employer also pays payroll taxes to the federal government for these programs (in addition to the amount an employee pays). Federal income tax and the Medicare tax have no limit, but the Social Security payroll tax always carries a cap. In 2008, Social Security tax topped out at 6.2 percent on an earnings maximum of $102,000. Generally, income tax is considered a progressive tax--higher incomes are taxed at a greater percentage than lower incomes--and payroll tax is regressive---that is, it makes up a larger percentage of income as earnings fall. Source: /www.ehow.com

The Federal Government’s Income Federal revenue comes from several different sources: 2 3 Chapter 16, Section 1

Taxing for Nonrevenue Purposes Besides taxing for revenue purposes, the Federal Government sometimes taxes for the purpose of regulating and even discouraging some activity that Congress thinks is harmful or dangerous to the public. The Supreme Court has upheld Congress’s taxing for nonrevenue purposes. However, the Supreme Court can still rule a tax unlawful if it finds that the tax was imposed for improper reasons. 2 3 Chapter 16, Section 1

What other Taxes Do You Pay?

Progressive Taxes A progressive tax is a tax in which the tax rate increases as the taxable base amount increases.] The term "progressive" describes a distribution effect on income or expenditure, referring to the way the rate progresses from low to high, where the average tax rate is less than the marginal tax rate. The term can be applied to individual taxes or to a tax system as a whole; a year, multi-year, or lifetime. Progressive taxes are imposed in an attempt to reduce the tax incidence of people with a lower ability-to-pay, as such taxes shift the incidence increasingly to those with a higher ability-to-pay. The opposite of a progressive tax is a regressive tax, where the relative tax rate or burden increases as an individual's ability to pay it decreases. The term is frequently applied in reference to personal income taxes, where people with more income pay a higher percentage of that income in tax than do those with less income. It can also apply to adjustment of the tax base by using tax exemptions, tax credits, or selective taxation that creates progressive distribution effects. For example, a sales tax on luxury goods or the exemption of basic necessities may be described as having progressive effects as it increases a tax burden on high end consumption or decreases a tax burden on low end consumption respectively. Source: Wikipedia

Consumption Taxes A consumption tax is a tax on spending on goods and services. The tax base of such a tax is the money spent on consumption. Consumption taxes are usually indirect, such as a sales tax or a value added tax. However, a consumption tax can also be structured as a form of direct, personal taxation, such as the Hall–Rabushka flat tax. Value-added tax A value added tax (VAT) applies to the market value added to a product or material at each stage of its manufacture or distribution. For example, if a retailer buys a shirt for $20 and sells it for $30, this tax would apply to the $10 difference between the two amounts. A simple VAT would be proportional on consumption but also be regressive on income at higher income levels (as consumption falls as a percentage of income). Savings and investment are tax-deferred until they become consumption. A VAT may exclude certain goods, intent being creating progressive effects. The tax is used in countries within the European Union. Sales tax A sales tax typically applies to the sale of goods, less often to the sales of services. The tax is applied at the point of sale.

Consumption Taxes Excise tax An excise tax is a sales tax that applies to a specific class of goods, typically alcohol, gasoline (petrol), or tourism. The tax rate varies according to the type of good and quantity purchased and is typically unaffected by the person who purchases it. Expenditure tax A direct, personal consumption tax may take the form of an expenditure tax or an income tax that deducts savings and investments, such as the Hall–Rabushka flat tax. A direct consumption tax may be called an expenditure tax, a cash-flow tax, or a consumed-income tax and can be flat or progressive. Expenditure taxes have been briefly implemented in the past in India and Sri Lanka. This form of tax applies to the difference between an individual's income and increase/decrease savings. Like the other consumption taxes, simple personal consumption taxes are regressive with respect to income. However, because this tax applies on an individual basis, it can be made as progressive as a progressive personal income tax. Just as income tax rates increase with personal income, consumption tax rates increase with personal consumption. Source: Wikipedia

What is the Fair Tax?

S E C T I O N 2 Nontax Revenues and Borrowing What are the nontax sources of government revenues? How does the Federal Government borrow money? What are the causes and effects of the public debt? 1 3 Chapter 16, Section 2

Nontax Revenues and Borrowing Nontax revenues come from a variety of sources, including canal tolls; fees for passports, copyrights, and patents; interest earned; and selling philatelic stamps. Borrowing Congress has the power “[t]o borrow Money on the credit of the United States.” (Article I, Section 8, Clause 2). A deficit is the shortfall between income and spending. A surplus is more income than spending. Congress must authorize all federal borrowing. 1 3 Chapter 16, Section 2

The Public Debt The public debt is the government’s total outstanding indebtedness. It includes all of the money borrowed and not yet repaid, plus the accrued, or accumulated, interest. 1 3 Chapter 16, Section 2

Causes and Effects of the Public Debt Deficit financing Failure to repay the debt over time Interest accruing on the existing debt Effects: Increased revenue needed to pay off the debt Fears of financial obligations for tomorrow’s taxpayers 1 3 Chapter 16, Section 2

History of Public Debt

Public Debt By Country

S E C T I O N 3 Spending and the Budget What are the key elements of federal spending? How do the President and Congress work together to create the federal budget? 1 2 Chapter 16, Section 3

Federal Spending 1 2 Spending Priorities Spending by the Federal Government accounts for billions of dollars and has effects on the economy as a whole. Spending Priorities Entitlements are benefits that federal law says must be paid to all those who meet the eligibility requirements. Entitlements are the largest sector of government spending. Interest on the public debt has grown to be the second largest category of federal spending. Outlays for defense spending account for another large section of the federal budget. 1 2 Chapter 16, Section 3

Entitlement Spending

Federal Spending

Creating the Federal Budget 1 2 Chapter 16, Section 3