Government and the United states economy Chapter 12

Government’s role in the economy Four important referee roles of government in the economy: To enforce private property rights To monitor external costs and benefits To ensure market competition To protect consumers Enforce private property rights: Necessary rules and regulations Neutral party needs to intervene and insure that the market system function properly and fairly Monitor externalities: Externality: an economic side effect of producing or consuming a good or service that generates benefits or costs to someone other than the person who decides how much to produce or consume External: fall beyond the control of the producer or consumer EPA: Environmental Protection Agency: deals with external costs by setting and enforcing standards for clean air and water

Government’s Role cont… Ensure market competition: Predatory pricing: selling a product below its cost with the goal to drive competitors out of business Existing businesses agree to temporarily drop their prices to force out of the market a competitor who can’t match their price To ensure market competition in the U.S. CONGRESS has enacted antitrust laws. Trust: an illegal combination of companies into one company 4 key laws that form the basis of antitrust legislation

4 key laws of antitrust legislation: The Sherman Antitrust Act of 1890: Made it illegal to create a monopoly, enter into a conspiracy to create a monopoly, or restrain trade Include agreements to fix prices, rig bids, and divide markets The Clayton Act of 1914: Prohibits certain business practices, such as giving special rates to certain customers if the practice lessens competition or tends to create a monopoly The Federal Trade Commission Act of 1914: Created the Federal Trade Commission (FTC) to enforce antitrust laws In 1938, the FTC was given the added responsibility of protecting the public against false or misleading advertising The Celler-Kefauver Act of 1950: amended the Clayton Act by broadening it to include any merger that lessens competition or tends to create a monopoly

Government’s role cont… Protect consumers: Food and Drug Administration National Transportation Safety Board Both are responsible for enforcing laws that protect the general public from faulty products or deceptive advertising Require that businesses comply with certain standards and rules when producing a good or service Ensure a level of safety and quality for consumers Prevent businesses from cutting corners to reduce costs

Government as a manager: Stabilize the economy Promote economic security Provide public goods and services STABILIZE the ECONOMY: Fiscal policy: uses government spending and taxation to stabilize the economy Monetary policy: involves regulating the money supply to help the economy achieve a full- employment, non-inflationary level of total output

Government as a manager: Promote Economic Security: Social Security and Medicare taxes and wages Programs to help poor, disables, and retired people fall into two categories: Increase income and the standard of living include Social Security and other retirement programs, welfare payments, Medicare and Medicaid, food stamps, and unemployment insurance Eliminate the causes of poverty and economic disadvantage include enforcement of anti- discrimination laws and provide for educational opportunities to help people develop skills and increase their labor productivity

Government as a manager: Provide public goods and services: Government is considered the PUBLIC sector of our economy, considered a service provider Public sector: part of the economy that involves the transactions of government Government’s emphasis on management: Veterans’ hospitals National security Business regulation Public good: once provided, it is available to anyone without additional cost

Federal government spending and taxation Fiscal year: a twelve-month period that can begin on any date Begins on Oct. 1 and ends on Sept. 30 the next year Federal government spending: Transfer payments: a transfer of money by a level of government to a household or business firm for which the payer (government) receives no good or service directly in return Federal government taxation: Income taxes Individual income taxes Social insurance and retirement FICA: Federal Insurance Contribution Act: Represents the taxes people pay for Social Security and Medicare

Tax Policy “in this world nothing can be said to be certain, except death and taxes.” Principle purpose of taxes is to pay the cost of government Taxes can discourage activities the government believes to be harmful Example: cigarettes/liquor “sin taxes” have been levied to raise money and discourage people from smoking and drinking Taxes as incentives: allows the firm that purchases new equipment to pay lower taxes as a result of the purchase Federal government can use tax policy to alter the level of economic activity. By increasing or decreasing taxes, government can affect overall spending and production = thereby, stabilizing the economy (fiscal policy)

Principles of taxation Benefits-received principle: States that government should tax people in proportion to the benefits they receive from a good or service Principle: those who benefit from good or services should pay for its use Ability-to-pay principle: States that the government should tax people in proportion to their ability to pay the tax

Types of taxes: Proportional Tax: (flat tax) Progressive tax: Tax for which the percentage of income paid in taxes is the same for all income levels Flat tax: as a person’s income goes up, the person’s income tax goes up by the same proportion Example: $100, 000/year vs. $25,000/year Proportional rate of 20% $25,000 would pay $5,000 in taxes $100,000 would pay $20,000 Progressive tax: Takes a higher proportion of income from higher income earner than from lower income earners Example: $25,000/year tax rate of 20%, someone earning $100,000/year tax rate of 40% As someone’s income goes up, the income tax goes up by a greater proportion Federal income tax is considered a progressive tax Regressive tax: Tax for which the percentage of income paid in taxes decreases as income increases Takes a higher percentage of income paid in taxes decreases as income increases Takes a higher percentage of taxes from low-income persons than from high-income persons

Characteristics of a good tax Efficient to collect Government must provide a good reason for imposing a tax Taxpayers must know what purpose their taxes will serve Must treat taxpayers fairly Must be certain Taxpayers must know when a tax is due, exactly how much it will be, and how to pay it correctly Paying a tax must be simple and convenient for the taxpayer

Debt and deficits Budget expenses exceed income, the difference is a deficit Income is greater that expenses, the difference is surplus National debt: cumulative sum of all federal government borrowing used to finance annual deficits Gross debt: the total of all the federal government’s IOU’s Publicly-held debt: the gross debt minus the amount government agencies have invested in government securities

Justification for Federal deficits and the national debt The national debt is not as large as it seems When our economy is sluggish or declining, the budget deficit might increase total spending in the nation This can occur if the government borrows and spends dollars that people have saved but which businesses are not investing

Criticisms of federal deficits and the national debt Annual interest payments on the national debt have been a large growing portion of the federal budget Unless budget deficits fall, interest payments will continue to rise in the future Large deficits might lead to higher interest rates To cover its deficits, the government can borrow money from the same places that businesses borrow: banks, corporations, and foreign lenders Cost of loans is in the form of interest is a price just like other prices If government borrowing adds significantly to the demand for available funds, interest rates might increase Deficits may reduce private investment Less investment in plants and equipment means that fewer new jobs will be created Deficits may trigger inflation A government may simply print money to finance its deficits or repay its debts This would increase the amount of money faster than the supplies of goods and services which people spend money on. Inflation would result.