nGnGovernment Expenditures and Revenues The Role of Government nTnTaxes – Types and Recent Issues nMnMore Fiscal Policy nBnBudgets and Fiscal Policy n National Debt

n Involves taxes - decrease = more demand - increase = less demand Fiscal and Monetary policy But First… Fiscal policy n Involves spending - leads to multiplier effect - target specific areas

n Involves interest rates - lower = more demand for money - increase = less demand for money Monetary policy n Involves money supply - more leads to lower interest rates - like German hyperinflation

billion billion billion billion Government Spending % of GDP /3 by the Federal government $ amount increases, but % is constant

Federal Government expenditures as a share of GDP have risen over time. The Size of Government State & local Government Expenditures as a Share (%) of GDP

Federal As is shown here, government expenditures as a share of GDP have risen over time. The Size of Government State & local Government Expenditures as a Share (%) of GDP

How the Government Spends Education 14 % Misc. expenditures 13 % Transportation 4 % Public safety and judicial 5% Environment and housing 5 % Interest 10 % National defense 11% Social Security 13 % Other transfers 13 % Health care 12 % Sources: U.S. Census Bureau, Summary of State and Local Government Finances of Government, and Office of Management and Budget, Budget of the United States Government.

How the Federal Government Spends Sources: Economic Report of the President, 2004, and Statistical Abstract of the United States, A breakdown of the government expenditures at the federal level in 2003 are listed above. 18.8% 7.1% Transportation Other 22% Income Security Medicare and health Defense Net Interest Social Security 3.1% 11.8% 21.7% 15.5%

How State & Local Government Spends Government expenditures at the state and local level in 2000 Sources: Economic Report of the President, 2004, and Statistical Abstract of the United States, Insurance trusts Public welfare & Health Police & Fire Protection Transportation Utilities & liquor stores Education Administration & other Interest on debt 22.3% Public welfare & Health 7.7% 32.2% 12.2% 4.3% 7.1% 6.3% 7.9%

1. Purchases 27% Government Spending a. Public Goods - people can’t be excluded from using - can be consumed jointly - lighthouses, national defense b. Quasi-Public Goods - not produced in enough quantity - police protection, parks, fire departments

Examples of public goods: national defense radio and television broadcast signals clean air.

1.Which of the following are public goods? (using the definition of a public good.) a. An anti-missile system surrounding Washington. b. A fire department. c. Tennis courts. d. Shenandoah National Park. e. Elementary schools a. An anti-missile system surrounding Washington.

2. Transfer payments 43% - Social Security -Unemployment -Veterans benefits 3. Money to State and Local 13% Governments 4. Interest payments on 14% borrowed money (bonds) 5. Government enterprises 3%

Sources of Government Revenues at the federal, state, and local level, are listed below. Misc. revenue 12 % Individual income taxes 14 % Corporate income taxes 12 % Property taxes 8 % Sales taxes 11 % User charges 14 % Payroll taxes 14 % Sources: U.S. Census Bureau, Summary of State and Local Government Finances of Government, and Office of Management and Budget, Budget of the United States Government.

Individual Income Tax 50 % Social Insurance 32 % Corporate Income Tax 10 % Excise Tax 3 % Customs, Estate, Gift Tax 2 % Misc 2 % Federal Government Revenue

Federal taxes: State & local taxes: How Government Taxes: Taxes vary by state Corporate income 12% Excise taxes 4% Customs duties 1% Corporate income 2% Other 4% Other 3% Property 15% Payroll 12% Personal income 10% User charges a 24% Sales and excise 17% From federal government 16% Payroll 34% Personal income 46% FL. MI, NH, DE (?) – no Income Tax NH motto: Live free or die... but they have a tax on parachute jumps

A. Types of Taxes or how the tax changes with income changes u Progressive tax is one in which the average tax rate rises with income. - tax brackets u Proportional tax is one in which the average tax rate stays the same across income levels. - flat tax, sales tax? u Regressive tax is one in which the average tax rate falls with income. - sales tax – higher income spend lower proportion on taxable goods Taxes!!!!!

n A sales tax of 7 % on medicine n A state income tax with 3 tax brackets n A property tax of $2.85 per $100 of assessed property value n A tax of $8 on room occupancy in all city hotels n A tax of 3 % on all wages earned in the city n A sales tax of 5% on utilities n A federal tax of $2 per pack of cigarettes.

n 1 side: keep taxes to provide more armed forces, police patrols,… B. Tax Reform n 1 side: reduce taxes, encourage business investments 1. Arguments n 1981: Economic Recovery Act – adjusted income for inflation n 1986: Tax Reform Act - lowered max tax from 50% to s Tax Reforms

n Tax base: the level of the activity that is taxed. u Property u Sales u Income Tax Base

n Tax rate : the rate (%) at which an activity is taxed. Tax Rate n declining/eroding tax base: people are moving from urban to rural or suburbs. n abatement: tax incentives to lure businesses (lower rates). n Tax rate/base issues :

n Speed things up: - increase government purchases - increase transfers - decrease taxes To review… Fiscal policy n Slow things down - decrease government purchases - decrease transfers - increase taxes

n Discretionary: adjustments in spending levels or tax rates - actions by President or Congress Types of Fiscal policy n Automatic - rates are set - increased consumer spending increases revenues - decreased consumer spending reduces revenues Automatically

n Types of budgets: 1. Balanced: Expenditures = Revenues 2. Surplus: Expenditures < Revenues 3. Deficit: Expenditures > Revenues Spending Plan – formal or informal

(estimate) (estimate) (estimate) -829

n Gramm-Rudman-Hollins Act (1986?) - show plan for balanced spending, but… Concern over the Deficits n Budget Enforcement Act (1990) - to increase spending, cut something else Deficits total $5.629 trillion in 2000

n Borrow at lowest interest rate n US Treasury securities: (type depends on length) 1. US Treasury Bill: 1 year or less 2. US Treasury Note: 1 to 10 years 3. US Treasury Bond: over 10 years Sum of all surpluses and deficits Financing the Debt

Effect on the Country - interest must be paid - $362 billion % of Federal spending Crowding Out Government competes for the funds - interest rates go up - borrowing by businesses goes down

Chapter 6 Questions 1.Which of the following statements about public goods is FALSE? a.A person must pay to use a public good. b.A lighthouse is an example of a public good c.No one can be excluded from using a public good. d.Public goods are provided for all members of society. 2. The primary source of revenue for the federal government is: a.excise taxes. b.corporate income taxes. c.individual income taxes d.tax receipts from state and local governments. 3. The federal personal income tax is generally regarded as a: a.flat tax.b.regressive tax. c.progressive taxd.proportional tax. 4.If the economy were experiencing a high rate of unemployment, an appropriate corrective measure by the federal government would be to reduce: a.transfer payments. b.personal income taxes c.purchases of military equipment. d.the number and amount of bribes Congressmen can accept.

5. If government expenditures were less than tax revenues, the government would be operating with a: a.deficit budget b.surplus budget. c.balanced budget. d.budget that would tend to lead to inflation. 6. If the economy were experiencing high rates of inflation, the LEAST appropriate federal government policy would be to operate with a: a.deficit budget b.surplus budget. c.balanced budget. d.budget having both on-budget and off-budget expenditures. 7.The national debt is the total accumulated debt of: a.the federal government b.the federal government plus all state and local governments. c.all private borrowers in the United States. d.all government and private borrowers in the United States. 8. Forcing private borrowers out of the market because government borrowing has raised the rate of interest is: a.crowding outb.interest rate shock. c.the demand shift effect.d.government foreclosure.