Chapter 13: Government Spending, Taxing, and National Debt

Size of Government Government expenditures as a percentage of GDP have grown from 23% in 1960 to % in 199 Expenditures of Federal government have risen from 17% to % of the GDP between 1960 and 199

Components of Government Expenditures Government purchases of goods and services have remained stable at about 20% of the GDP in Transfer payments have grown from 6% to 1% of the GDP over this period

Taxes Tax revenues as a percentage of the GDP increased from 26% in 1960 to 30% in 1999 Federal tax receipts rose from 18% to 20% of the GDP over this period

Role of Government: Public Goods Non-rival in consumption: use by one person will not require loss of consumption by another person Non-exclusive: no one can be excluded from consumption once it is produced Free-rider problem: everyone uses regardless of tax payments

Role of Government: Externalities Benefits and costs of one’s consumption and production to third parties Positive externalities require government subsidies (college education) Negative externalities require government taxes or regulations (pollution)

Positive Externalities: MSB>MPB Price Quantity MPB P P’ QQ’ A MSB B MPC=MSC

Negative Externalities: MSC>MPC Price Quantity MSC P P’ Q’Q MPC B A MSB=MPB

Role of Government: Income Distribution Progressive taxation and transfer payments to bridge income gap between the rich & poor Horizontal equity: people with equal income pay equal amount of tax regardless the source of income Vertical equity: people with higher income pay larger taxes

Incidence of Tax: Inelastic Demand Quantity Price P1 Q1 D D S S P2 S’ Tax is paid by consumer: Forward shifting Tax

Incidence of Tax: Elastic Demand Price Quantity S’ P Q1 D D S S Q P1 Tax Tax paid by producer: Backward shifting

Comparative Data U.S. tax share of the GDP is 31.5% It is the smallest among industrial nations The highest share belongs to Denmark, 60%

Composition of Tax Receipts: Individual income tax share rose from 39.9 to 47.8% Corporate income tax share fell from 26.5 to 10% Social security tax share rose from 11 to 33.8% Excise tax share fell from 19.1 to 3.7%

Effective Federal Income Tax Rates, 1996 Income bracket, $Tax rate, % Less than 10, ,000 – 20, ,000 – 30, ,000 – 50, ,000 – 70, ,000 – 100, ,000 – 200, More than 200,

Federal Budget Account ($ billions) YearReceiptsSpendingBalance 19931,1541, ,2591, ,3521, ,4531, ,5791, ,6581, ,7431,802+69

Public Debt Government borrows money from investors through the issuance and sale of government securities or bonds Investors hold the bonds for a certain time period to make interest income

Government Securities Non-marketable securities –U.S. Savings Bonds & Notes: redeemable in cash for the face value after maturity Marketable securities –Treasury bills (< 1 year; low interest rate) –Treasury notes (1-5 years) –Treasury bonds (> 5 years, high interest rate)

National Debt Government borrowing to cover budget deficit Debt id owed to –Private investors –Banks and financial institutions –Insurance companies –State & local governments –Foreign governments and private investors

Budget & Debt YearBudget Surplus National Debt Debt Repayment In $ billions , *795, *1175, *1345, *1875, * Estimates

Economic Effects of Federal Debt Primary burden: opportunity cost of servicing the debt in terms of reduced public investment Inflationary effect: higher interest rates and prices

Economic Effects of Federal Debt Income distribution effect: income transfer from government to high income investors Output effect: higher taxes and opportunity cost of productive investment