Oliver Wendell Holmes Jr. “Taxation is the price we pay for civilization.”

Characteristics of a Good Tax: Convenience Not overly complicated, predictable Efficiency Keep economic costs of tax system low Certainty Not arbitrary! (Prevents abuse) Equity Rich should pay more than poor Adam Smith’s Tax Maxims from “The Wealth of Nations”

Come up with a list of items, services, etc Come up with a list of items, services, etc. that should be taxed to pay for government services. Gain revenue Discourage/encourage behavior Fair? Enforceable?

Unit 5 Quiz 2 Notes LT 3 & 4 3) I can explain how the government generates revenue and makes spending decisions. 4) I can explain the two tools the Federal Government uses for contraction/expansion fiscal policies.

Make a list of all of the federal taxes you can think of, and another list of all of the state taxes you can think of. State Federal

Federal Taxes: Individual income tax Corporation income tax Employment tax Gift tax Excise taxes Estate tax

Minnesota State Taxes: Alcoholic beverage tax Cigarette and tobacco tax Contamination tax Controlled substance tax Corporate franchise tax Corporate franchise tax for nonprofit organizations (UBIT) Dry cleaner fees Estate and trust tax Fur clothing tax Hazardous waste generator tax Individual income tax Insurance taxes Lawful gambling tax Metropolitan landfill fee Mineral taxes Minnesota Care Mortgage registry tax/deed tax Partnership tax Petroleum taxes Property tax REA membership tax S Corporation tax Sales and use tax Solid waste management tax Withholding tax Use tax for individuals

Why are taxes collected? What is a tax? A required payment to a local, state, or national government Why are taxes collected? Taxation is the primary way that the government collects money (revenue) that is used to provide goods and services to us.

Why do people often DISLIKE paying taxes? The government has a monopoly on force Most economic transactions depend on voluntary exchange. Government has the exclusive right to coerce individuals to pay taxes. 2. Costs are obvious; benefits are not. diminished link between payment and individual consumption no easily noticeable direct benefit from the goods or services received benefits are spread thinly or delayed (cancer research, national defense)

Characteristics of a Good Tax: Convenience Not overly complicated, predictable Efficiency Keep economic costs of tax system low Certainty Not arbitrary! (Prevents abuse) Equity Rich should pay more than poor Adam Smith’s Tax Maxims from “The Wealth of Nations”

Tax Equity Tax equity begins with the belief that taxation should be fair to all who are taxed. Economists often cite two principles in debates over tax equity:

Defining taxes Tax base (Incidence of tax) Who bears the tax (what is being taxed) Single/married adult’s income (Income tax) Value of good/service- buyers (sales tax) Company profits (Corporate Income tax) Tax Structures How a particular tax is collected:

Proportional Taxes (a type of tax structure) Tax Base: Personal Income Definition: The percentage of income paid in taxes remains the same for all income levels. A 6% proportional income tax Leslie makes $350,000/yr and Tony makes $50,000/yr. Leslie pays 6% of her $350,000 ($21,000) Tony pays 6% of his $50,000 ($3,000) Example: Income tax in Estonia, Slovakia, & some other European Countries

Proportional Everyone pays the same percentage of their income Income Tax Paid $ Contribution-% of Income 10,000 20% 40,000 20% 80,000 20% $2,000 $8,000 $16,000

Progressive Taxes (structure) Tax Base: Personal Income Definition: The percentage of income paid in taxes increases as income increases. Example: U.S. federal income tax2015 Tax Brackets

Regressive Taxes (structure) Tax Base: Specific good or service Definition: A single tax rate is applied to everyone. The percentage of income paid in taxes decreases as income increases. Although the tax rate remains constant… Higher-income households spend a lower proportion of their incomes on taxable goods and services. The proportion of their income spent on sales taxes is lower than that of lower-income households. Example: Sales tax

Regressive Everyone pays the same dollar amount, regardless of income Income Tax Paid $ Contribution-% of Income $10,000 $2,000 $40,000 $2,000 $80,000 $2,000 20% 5% 2.5%

Which is fair? Regressive: $10,000 Proportional: $10,000 Betty: $100,000 Flo: $20,000 Regressive: $10,000 Proportional: $10,000 Progressive: $10,000 Regressive: $10,000 Proportional: $2,000 Progressive: $500

How to states tax differently?

Where do your MN tax dollars go?

Who plans the budget? President and advisors set budget proposal (18 mos. in advance) Until the final draft is due, citizens, Congress, and the President debate issues concerning money allocation Congress approves final draft OMB Manages budget

Three possible budget outcomes: BALANCED BUDGET: total revenue = total spending BUDGET SURPLUS: total spending < total revenue BUDGET DEFICIT: total spending > total revenue …sometimes the President plans for one of these conditions…

How can government spend money it does not have? Borrow money by selling government securities (bonds, T-bills, etc) increases gov. spending (cash available to cover expenses) But…adds to National Debt (the total amt. of money owed to bondholders) Right now the estimated national debt is: Debt Clock

Government Spending Expenditures Mandatory: required/fixed by law Social security, interest to pay national debt Discretionary: Lawmakers can choose where money should go, fluctuates year to year Education, defense, research, etc All government expenditures require a budget that must be planned annually Altering expenditures and revenue (taxes) is called Fiscal Policy

Federal Spending Mandatory (60%): Money that lawmakers are required by existing laws to spend on certain programs or to use for interest payments on the national debt Discretionary (40%): Spending about which government planners can make choices

Mandatory Spending

Discretionary Spending

Unit 5 Quiz 2 Notes LT 3 & 4 3) I can explain how the government generates revenue and makes spending decisions. 4) I can explain the two tools the Federal Government uses for contractionary/expansionary fiscal policies.

Consider this situation: Output (GDP) is down Many people are getting laid off from their jobs People have less discretionary income, so aggregate demand (spending) is down Businesses continue to suffer and are forced to lay off more and more workers WHAT SHOULD THE GOVERNMENT DO?

Encourage Economic Growth! Increase aggregate demand!!! Prices will rise Suppliers will want to produce more People will get hired back to their jobs People will feel comfortable spending money again The economy will expand 

The use of taxation and government spending to control the economy. Fiscal Policy The use of taxation and government spending to control the economy.

Role of government in the economy Classical Keynesian (John Maynard Keynes) Recessions caused by events outside market Wars Crop failures Time heals wounds Market will adjust, return to equilibrium Gov’t role should be minimal Gov’t intervention in the economy is the best way to ensure economic stability Government leaders use fiscal policy to increase overall demand Cut taxes (more $ for people to spend Increase gov’t spending (borrow $ to do this, deficit spending)

EXPANSIONARY FISCAL POLICY We call this… EXPANSIONARY FISCAL POLICY Tool #1: Tool #2: INCREASE GOVERNMENT SPENDING CUT TAXES Government buys more goods & services Companies that sell goods to the government earn profits, which they use to pay their workers more & hire new workers Workers have more money & spend more in shops & restaurants Shops & restaurants buy more goods and hire more workers to meet their needs In the short term, government spending leads to more jobs and more output When tax rates go down, individuals have more money to spend and businesses keep more of their profits Consumers now have more money to spend on goods and services Businesses now have more money to spend on land, labor and capital These actions will increase demand, prices, and output

Government Spending and the Multiplier Effect

Who gets the tax cut? Keynesian Supporters Supply-Side Economists Demand-Side Economists Keynesian Supporters Best way to expand economy (Stimulate demand) Cut individual income tax Consumers spend tax savings on goods & services Business will improve Economy will begin to grow? “Reaganomics” (Trickle Down) Best way to expand economy (Stimulate supply) Cut taxes on businesses & wealthy Invest tax savings to expand production Supply of goods increases Economy will begin to grow?

Now, consider this situation: Fast-growing demand is exceeding supply Producers who cannot increase output levels are forced to increase their prices Inflation occurs, cutting into consumers’ purchasing power & discouraging economic growth and stability WHAT SHOULD THE GOVERNMENT DO?

Slow Down Economic Growth! Decrease aggregate demand!!! Keep prices low Suppliers will cut production/lay off workers Lower production will slow the rate of growth of the economy Inflation will not occur GDP may even decline

CONTRACTIONARY FISCAL POLICY We call this… CONTRACTIONARY FISCAL POLICY Tool #1: Tool #2: DECREASE GOVERNMENT SPENDING INCREASE TAXES Government buys less goods & services There is a decrease in aggregate demand because the government is buying less than before Prices of goods and services drop Suppliers produce less & possibly fire workers Lower production slows down the rate of growth of the economy Individuals have less money to spend on goods & service, or to save for the future Businesses keep less of their profits and decrease their spending on land, labor, and capital As demand decreases, prices fall Suppliers produce less & possibly fire workers Lower production slows down the rate of growth of the economy

What are the limits of Fiscal Policy? increasing/decreasing federal spending not easy Lawmakers argue validity of statistics a rationale The results of fiscal policy are often delayed, is it working or not? The President/Lawmakers want to get re- elected and may cut taxes/increase government spending even when it’s not the best thing for the economy! Coordination between all levels of government is difficult.