Financing Government: Taxes and Debt Chapter 30 Financing Government: Taxes and Debt 4/16/2017 ©1999 South-Western College Publishing

In what possible three ways do we pay for government spending? Taxes Debt Inflation (via printing of money) ©1999 South-Western College Publishing

What does government spending have to do with Opportunity Costs? A dollar spent by the military on an airplane is a dollar that cannot be spent on a new house ©1999 South-Western College Publishing

Or how we pay for government Taxes, taxes, taxes Or how we pay for government

Why Pay Taxes? Quote from Oliver Wendell Holmes: “Taxes are the price we pay for civilization”

Classifying taxes in relation to income Proportional Progressive Regressive

What is a Proportional Income Tax? A tax that is a fixed percentage of income, regardless of the level of income, a flat rate tax ©1999 South-Western College Publishing

What is a Progressive Income Tax? A tax whose rate varies directly with the income of the person taxed; rich people pay a higher rate ©1999 South-Western College Publishing

What is a Regressive Income Tax? A tax whose impact varies inversely with the income of the person taxed; as a percentage, poor people pay the most ©1999 South-Western College Publishing

Classifying taxes in relation to income Proportional: as income rises, the same % of income is paid in tax (flat tax) Progressive: as income rises, a higher % of income is paid in tax (graduated rate) Regressive: as income rises, a lower % of income is paid in tax

10% Proportional tax Income Tax Tax/income $30,000 $3,000 .10 (10%) $30,000 $3,000 .10 (10%) $40,000 $4,000 .10 (10%) $50,000 $5,000 .10 (10%)

Progressive tax: Hypothetical marginal tax brackets Income from 0-$20,000 taxed at 10% Income from 20-$40,000 taxed at 20% Income over $40,000 taxed at 30%

Progressive tax Income Tax Tax/income $30,000 $4,000 .13 (13%) $30,000 $4,000 .13 (13%) $40,000 $6,000 .15 (15%) $50,000 $9,000 .18 (18%)

Examples of regressive taxes Poll taxes Sales taxes Social security tax

What is a Poll Tax? A tax of a specific absolute sum levied on every person or every household ©1999 South-Western College Publishing

Why are sales and Excise Taxes regressive? Because low income people spend a larger percentage of their income on purchases than high income people ©1999 South-Western College Publishing

Major Federal Taxes Personal income tax Social security taxes (payroll tax) Corporate income tax

State and local taxes States: sales and income taxes Local: property and real estate taxes

What is a Corporate Income Tax? A tax levied on a corporation’s income before dividends are distributed to stockholders ©1999 South-Western College Publishing

For information and statistics concerning taxes: http://www.us.gov http://www.irs.ustreas.gov/prod/tax_stats ©1999 South-Western College Publishing

How are Income Taxes Progressive in the U.S.? Most people are in either the 15% or 28% tax bracket, but some are in the 31%, 36%, or 39.6% bracket ©1999 South-Western College Publishing

What are Exemptions and Deductions? They are both subtracted from gross income to determine taxable income ©1999 South-Western College Publishing

Visit a few organizations that advocate tax reform: http://www.atr.org http://www.ctj.org http://www.cats.org ©1999 South-Western College Publishing

Theories of taxation Ability to pay: tax in accordance with ableness to pay--suggests using income and wealth taxes Benefits theory: tax those who benefit from the programs that the taxes are used to finance--gas taxes, license fees

Tax Incidence Who really pays a tax and thus bears its burden? Incidence is complicated by tax shifting

Shifting of taxes Forward: to the consumer Backward: to the worker or resource supplier

Government budgets If G=T, balanced budget If G>T, deficit If G<T, surplus

What is a Federal Deficit? A Deficit occurs when the government spends more than it receives in tax revenues ©1999 South-Western College Publishing

Where does government get the money when there is a deficit? Borrow the money by selling treasury bonds, notes, etc. known as government securities

What are the different kinds of securities? Treasury ... Bills Bonds Notes ©1999 South-Western College Publishing

What is a Treasury Note? A Treasury bond that matures in 2 to 10 years and is sold in denominations as low as $1,000 ©1999 South-Western College Publishing

What is a U.S. Savings Bond? A nonmarketable Treasury bond that is the most commonly held form of public debt ©1999 South-Western College Publishing

What is a Treasury Bond? A Treasury Bond takes 30 years to mature and is sold in denominations as low as $1,000 ©1999 South-Western College Publishing

What is a Treasury Bill? A bond that matures in 3, 6, or 12 months with minimum denominations of $10,000 and multiples of $5,000 above this ©1999 South-Western College Publishing

What is the Public (national) Debt? The total value of government securities held by individuals, businesses, other government agencies, foreigners, and the Federal Reserve ©1999 South-Western College Publishing

Budget Philosophies 1. Annually balanced 2. Cyclically balanced 3. Functional finance

Annually balanced budget Try to set G=T each year Problem: could be destabilizing to the economy

G rises, T falls, deficit (cyclical) arises Start with G=T Recession hits G rises, T falls, deficit (cyclical) arises In order to balance budget, either raise T or lower G, but this is contractionary policy Could worsen recession

Cyclically balanced budget Balance the budget over the course of the business cycle, not necessarily each year

Cyclically balanced budget GDP Expansions, run surpluses Recessions, run deficits Time

Functional finance Balance the economy, not the budget: shoot for full employment, stable prices, regardless of the budget

Cyclical vs structural budget Structural: what the budget would be with existing tax laws and spending programs, assuming full employment Cyclical: difference between the actual budget and the structural

Example Say present deficit is 200 billion, unemployment rate is 7%: assume full employment is 5%: at full employment suppose the deficit would only be 50 billion: then 50 billion is the structural deficit, the other 150 billion is the cyclical deficit

Why is an internally financed public debt not a burden to future generations? Because even though people pay taxes to finance the debt, they also receive interest payments ©1999 South-Western College Publishing

Why is an externally held debt a burden to future generations? Because people pay taxes to finance the debt without receiving the interest payments ©1999 South-Western College Publishing

What are some problems with the National Debt? Not everyone holds the debt It promotes overconsumption It can create inflation It can crowd out private investment ©1999 South-Western College Publishing

For the latest statistics on the Public Debt: http://www.publicdebt.treas.gov ©1999 South-Western College Publishing

Visit the national debt clock

When the government spends a dollar, do we always pay for that dollar? In what possible three ways do we pay for that dollar? What does government spending have to do with Opportunity Costs? What are alternative ways to levy taxes? What is a Social Security Tax?

How are Income Taxes Progressive in the U.S.? What does it mean that each dollar of income is taxed on the Margin? What is a Federal Deficit? What is the Public Debt? What are the different kinds of securities? Treasury … What are some problems with the National Debt?

END ©1999 South-Western College Publishing