4 The U.S. Economy: Public and Private Sectors

Chapter Objectives Important Facts About U.S. Households and U.S. Businesses Corporate Form Domination in Sales and Profits Principle and Agent Issues Economic Role of Government in the Economy Categories of Government Spending and the Sources of Government Revenues

Households as Income Receivers Functional Distribution of Income-2005 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

Households as Income Receivers Personal Distribution of Income-2004 Personal Income Received (Percent) 0 10 20 30 40 50 60 Lowest 20% 3.4% Second 20% 8.7% Income Group (Households) Middle 20% 14.7% Fourth 20% 23.2% Highest 20% 50.1% Source: Bureau of the Census

Households as Spenders Household Uses of Income-2005 Household Income Expended (Percent) 0 10 20 30 40 50 60 70 80 90 Personal Taxes 12% Personal Saving 0% Income Group (Households) Personal Consumption 88% Consumption Divided Between… Composition of Consumption 59% 29% 12% Services Nondurable Goods Durable Goods Source: Bureau of Economic Analysis

The Business Population Plant Firm Industry Multiplant Firms Vertically Integrated Conglomerates

Legal Forms of Business Sole Proprietorship Partnership Corporation Domestic Output by Business Type 20% Corporations 8% Partnerships Corporations 84% 72% Sole Proprietorships Partnerships 11% Sole Proprietorships 5% Percentage of Firms Percentage of Sales Source: U. S. Census Bureau

Legal Forms of Business Advantages of Corporations Corporate Securities Stock Bond Limited Liability Hiring of Specialists Unlimited Lifetime Principal-Agent Problem 4.1

The Public Sector: Government’s Role Providing the Legal Structure Maintaining Competition Monopoly Regulation Regulated Monopolies Antitrust Laws Sherman Act 1890

The Public Sector: Government’s Role Redistributing Income Transfer Payments Market Intervention Taxation Reallocating Resources Market Failure Externalities or Spillovers Negative or Positive Types 4.2

The Public Sector: Government’s Role Correcting for Negative Externalities Legislation Specific Taxes Correcting for Positive Externalities Subsidize Consumers Subsidize Suppliers Provide Goods Via Government

The Public Sector: Government’s Role Public Goods and Services Private Goods Rivalry Excludability Public Goods Nonrivalry Nonexcludability Free-Rider Problem Quasi-Public Goods The Reallocation Process

The Public Sector: Government’s Role Promoting Stability Unemployment Inflation Government’s Role: A Qualification Political Context Overregulation Underregulation Benefits and Costs Not Perfectly Carried Out

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

Government Finance Government Purchases Government Transfers 35 30 25 20 15 10 5 Government Transfer Payments 31% 27% 12% 5% Percentage of U.S. Output 22% 19% Government Purchases 1960 2005

Government Finance GLOBAL PERSPECTIVE Total Tax Revenue – Selected Nations Percent of Total Output-2004 10 20 30 40 50 Sweden Denmark Norway Finland France Italy United Kingdom Germany Canada Australia United States Japan South Korea 50.7 49.6 44.9 44.3 43.7 42.2 36.1 34.6 33.0 31.6 25.4 25.3 24.6 Source: Organization for Economic Cooperation and Development

Federal Finance Federal Expenditures-2005 35% 20% 17% 7% Four Stand-Out Areas of Spending 0 10 20 30 40 50 Pensions & Income Security 35% National Defense 20% Health 17% Interest on the Public Debt 7% Source: U. S. Office of Management and Budget

Federal Finance Progressive Tax Rates Marginal Tax Rate Federal Tax Revenues-2005 Progressive Tax Rates Brackets of Income Marginal Tax Rate Average Tax Rate

Federal Finance Federal Tax Revenues-2005 43% 37% 13% 3% 4% Basic Revenue Sources 0 10 20 30 40 50 Personal Income Tax 43% Payroll Taxes 37% Corporate Income Taxes 13% Excise Taxes 3% All Other 4% Source: U. S. Office of Management and Budget

State and Local Finance State Finances Primary Revenues Sales & Excise Taxes - 48% Personal Income Taxes - 34% Corporate Income Taxes & License Fees – Most of Balance Primary Expenditures Education – 35% Public Welfare – 28% Health & Hospitals – 7% Highways – 7% Public Safety – 4% Other – 19%

State and Local Finance Local Finances Primary Revenues 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%

Financing Social Security Last Word Demographic Changes Severe Long-Run Shortfall in Social Security Funding Annual Pay-as-You-Go Plan Impact of Baby Boomer Retirements 2017 Revenues Less Than Payments – Trust Fund Withdrawals Trust Fund Exhausted in 2041 Possible Benefit Reductions and Tax Revenue Increases

Financing Social Security Last Word Possible Solutions Stock & Bond Investments Payroll Tax Increases Individually Directed Accounts for Annuity Incomes Owned by Government Half of Payroll Deduction in Privately Owned and Managed Accounts – Phased in Over Time Consensus Solution to be Very Difficult

Key Terms Page functional distribution of income 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

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