C hapter 15 Financing Government: Taxes and Debt

Economic Principles Gottheil - Principles of Economics, 4e 2 Commandeering resources Commandeering money (taxes) Regressive, proportional, and progressive tax structures

Economic Principles Gottheil - Principles of Economics, 4e 3 Social Security taxes Government securities and public debt Internally and externally financing the debt

Gottheil - Principles of Economics, 4e 4 EXHIBIT 1PRODUCTION POSSIBILITIES CURVE

Exhibit 1: Production Possibilities Curve Gottheil - Principles of Economics, 4e 5 What is the opportunity cost of producing the first aircraft in Exhibit 1? The opportunity cost of producing the first aircraft is 500 houses.

Commandeering Resources Gottheil - Principles of Economics, 4e 6 What is the most direct method available for a government to acquire resources? The most direct method is to commandeer resources.

Commandeering Resources Gottheil - Principles of Economics, 4e 7 What is the most direct method available for a government to acquire resources? This is how the pharaohs built the pyramids, and how governments built roads during the Middle Ages.

Commandeering Resources Gottheil - Principles of Economics, 4e 8 What is the most direct method available for a government to acquire resources? The military draft is a modern form of commandeering resources for the military.

The Tax System Gottheil - Principles of Economics, 4e 9 How is the tax system related to commandeering resources? The tax system commandeers money, not resources. Remember that resources are land, labor, capital, and entrepreneurship.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e 10 Poll tax A tax of a specific absolute sum levied on every person or every household.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e 11 Regressive income tax A tax whose impact varies inversely with the income of the person taxed. Poor people have a higher percentage of their income taxed than do rich people.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e What is an example of a regressive income tax? One example is a poll tax.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e What is an example of a regressive income tax? Another example is a tax on consumption, such as a sales tax. Since poor people spend all of their income on consumption, while rich people save a portion of their income, a consumption tax is regressive.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e 14 Proportional income tax A tax that is a fixed percentage of income, regardless of the level of income.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e What is an example of a proportionate income tax? A flat-rate tax on personal income

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e 16 Progressive income tax A tax whose rate varies directly with the income of the person being taxed. Rich people pay a higher tax rate—a larger percentage of their income is taxed—than do poor people.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e What is an example of a progressive income tax? The current system of federal income taxation is progressive.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e 18 Corporate income tax A tax levied on a corporation’s income before dividends are distributed to stockholders.

Are We Really Paying High Taxes? Gottheil - Principles of Economics, 4e 19 True or false: Taxes as a percentage of GDP are higher in the U.S. than in any other rich industrialized country. False

Are We Really Paying High Taxes? Gottheil - Principles of Economics, 4e 20 Tax revenues in the U.S. were 34.3 percent of GDP. True or false: Taxes as a percentage of GDP are higher in the U.S. than in any other rich industrialized country.

Are We Really Paying High Taxes? 21 In comparison, tax revenues as a percentage of GDP were 40.6 in the United Kingdom, 43.4 in Canada, 45.1 in Germany, and 51.1 in France. True or false: Taxes as a percentage of GDP are higher in the U.S. than in any other rich industrialized country.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e 22 Property tax A tax levied on the value of physical assets such as land, or financial assets such as stocks and bonds.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e 23 Unit tax A fixed tax in the form of cents or dollars per unit, levied on a good or service.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e 24 Sales tax A tax levied in the form of a specific percentage of the value of the good or service.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e 25 Customs duty A sales tax applied to a foreign good or service.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e 26 Excise tax Any tax levied on a good or service, such as a unit tax, a sales tax, or a customs duty.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e Which of the following is a unit tax? a. A 7% tax on gasoline sales. b. A $10 tax on fishing rods. c. A 20% flat tax on income.

There’s More Than One Way to Levy Taxes Gottheil - Principles of Economics, 4e Which of the following is a unit tax? a. A 7% tax on gasoline sales. b. A $10 tax on fishing rods. c. A 20% flat tax on income.

Gottheil - Principles of Economics, 4e 29 EXHIBIT TAX RATE SCHEDULE FOR MARRIED PERSONS FILING JOINTLY Source: Internal Revenue Service, Instructions for Form 1040 (Washington, D.C.: Department of the Treasury, 2003), p. 13.

Exhibit 2: 2003 Tax Rate Schedule for Married Persons Filing Jointly Gottheil - Principles of Economics, 4e 30 Suppose that a married couple filing jointly had $100,000 in taxable income. According to Exhibit 2, how much federal income tax must this couple pay? On the first $7,000 they pay 10%, which equals $700.

Exhibit 2: 2000 Tax Rate Schedule for Married Persons Filing Jointly Gottheil - Principles of Economics, 4e 31 On the next $21,400 they pay 15%, which equals $3,200. Suppose that a married couple filing jointly had $100,000 in taxable income. According to Exhibit 2, how much federal income tax must this couple pay?

Exhibit 2: 2000 Tax Rate Schedule for Married Persons Filing Jointly Gottheil - Principles of Economics, 4e 32 On the next $40,400 they pay 25%, which equals $10,100. Suppose that a married couple filing jointly had $100,000 in taxable income. According to Exhibit 2, how much federal income tax must this couple pay? 10100

Exhibit 2: 2000 Tax Rate Schedule for Married Persons Filing Jointly Gottheil - Principles of Economics, 4e 33 On the final $31,100 they pay 28%, which equals $10,296. Suppose that a married couple filing jointly had $100,000 in taxable income. According to Exhibit 2, how much federal income tax must this couple pay? 10100

Exhibit 2: 2000 Tax Rate Schedule for Married Persons Filing Jointly Gottheil - Principles of Economics, 4e 34 Thus the married couple pays a total of $(700 + $ $10, ,736) = $22,746. Suppose that a married couple filing jointly had $100,000 in taxable income. According to Exhibit 2, how much federal income tax must this couple pay?

Gottheil - Principles of Economics, 4e 35 EXHIBIT 3FEDERAL, STATE, AND LOCAL GOVERNMENT REVENUES: 2002 ($ BILLIONS) Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, October 2003).

Exhibit 3: Federal, State, and Local Government Revenues: 2002 ($ billions) Gottheil - Principles of Economics, 4e 36 Income taxes are the largest single source of combined government tax revenues.

Financing Government Spending Through Debt Gottheil - Principles of Economics, 4e 37 Public debt The total value of government securities— Treasury bills, notes, and bonds—held by individuals, businesses, other government agencies, and the Federal Reserve.

Gottheil - Principles of Economics, 4e 38 EXHIBIT 5OWNERSHIP OF THE U.S. PUBLIC DEBT: 2002 (PERCENTAGE OF TOTAL) *Savings and loan associations, nonprofit institutions, credit unions, mutual savings banks, corporate pension trust funds, certain U.S. Treasury deposit accounts, and federally sponsored agencies. Source: Federal Reserve Bulletin (Washington, D.C., October 2003).

Gottheil - Principles of Economics, 4e 39 EXHIBIT 6ATHE FEDERAL DEBT Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).

Gottheil - Principles of Economics, 4e 40 EXHIBIT 6BTHE FEDERAL DEBT Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).

Exhibit 6: The Federal Debt Gottheil - Principles of Economics, 4e During what time period did the gross federal debt grow most rapidly? During the period between approximately 1980 and 2000.

Exhibit 6: The Federal Debt Gottheil - Principles of Economics, 4e Based on the data in panel b of Exhibit 6, in what year was federal debt as a percentage of GDP the largest? Spending on the war effort caused federal debt to be 125 percent of GDP.

Exhibit 6: The Federal Debt Gottheil - Principles of Economics, 4e True or false: Gross federal debt as a percentage of GDP has increased sharply during the 1990s. False. Gross federal debt as a percentage of GDP flattened out and then declined in the 1990s.

Exhibit 6: The Federal Debt Gottheil - Principles of Economics, 4e Compare panels a and b in Exhibit 6. What caused debt as a percentage of GDP to flatten out and then decline in the 1990s? Panel a shows that the gross federal debt increased through 1996.

Exhibit 6: The Federal Debt Gottheil - Principles of Economics, 4e Compare panels a and b in Exhibit 6. What caused debt as a percentage of GDP to flatten out and then decline in the 1990s? In order for debt as a percentage of GDP to flatten out when debt is still growing, GDP must grow as fast as debt.

Exhibit 6: The Federal Debt Gottheil - Principles of Economics, 4e Compare panels a and b in Exhibit 6. What caused debt as a percentage of GDP to flatten out and then decline in the 1990s? In the late-1990s gross federal debt actually began to decline.

Gottheil - Principles of Economics, 4e 47 EXHIBIT 7GROSS PUBLIC DEBT AS A PERCENT OF GDP FOR SELECTED ECONOMIES: 1998 Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000), p. 847.

Does Debt Endanger Future Generations? Gottheil - Principles of Economics, 4e 48 In one sense the answer is no. While the interest on future government debt must be paid by taxing the future economy, people in the future who own government bonds receive that interest as income.

Does Debt Endanger Future Generations? Gottheil - Principles of Economics, 4e 50 In another sense the answer is yes. For example, if future bondholders are rich, then the rich receive the interest income while the poor only bear the burden of higher taxes.

Does Debt Endanger Future Generations? Gottheil - Principles of Economics, 4e 51 In addition, increased government debt purchased by the Fed will increase the money supply, which can be inflationary.

Does Debt Endanger Future Generations? Gottheil - Principles of Economics, 4e 52 Another problem with increased government debt is that it tends to crowd out private investment, which slows the rate of economic growth. Debt promotes overconsumption since bond holders are not aware the source of interest is from the tax they pay.

Does Debt Endanger Future Generations? Gottheil - Principles of Economics, 4e 53 External debt Public debt held by foreigners.

Does Debt Endanger Future Generations? Gottheil - Principles of Economics, 4e 54 Recall from Exhibit 5 that foreigners are a major owner of U.S. public debt. In this case, future generations of U.S. citizens bear the burden of higher taxes to pay the interest that flows to foreigners.

Gottheil - Principles of Economics, 4e 55