1. Chapter 14: Taxes and Government Spending
How does the government collect revenue and on what is that revenue spent?

2. Crash Course: Taxes
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3. Economic Impact of Taxes
Taxes can affect resource allocation by raising the price of a product, which makes people buy less, which in turn results in the company cutting back on production.
Taxes can be used to encourage or discourage certain types of activities; sin taxes help raise revenue while discouraging liquor and tobacco.
Distribution of income is affected by taxes.
Taxes change the incentives to save, invest, and work, which affects productivity and economic growth.
The incidence of a tax—the person or company who actually pays it—is not necessarily the entity that is taxed; if a utility is taxed, for example, it may pass the burden of the tax on to its customers in the form of higher rates.

4. No single tax has all three of the criteria for effective taxes.
Characteristics and Types of Taxes
The three criteria for effective taxes are equity, simplicity, and efficiency.
No single tax has all three of the criteria for effective taxes.
Taxes in the United States are based on the benefit principle and the ability-to-pay principle.
The three types of taxes that exist in the United States today are proportional taxes, progressive taxes, and regressive taxes.

5. Alternative Tax Approaches
Lawmakers want to find new tax revenues that alter the tax burden.
A flat tax is proportional to individual income after a threshold is reached, without exemptions or deductions.
The advantage of a flat tax is its simplicity, but it would remove many incentives (such as home ownership) built into the current tax code.
A value-added tax (VAT) would tax a product at every stage of production on a national basis and would be used instead of an income tax.
Advantages of a VAT include the difficulty of producers to avoid paying it, its widely spread incidence, and its ease of collection.
The main disadvantage of a VAT is that consumers cannot attribute higher prices to the almost invisible tax.

6. Taxes Affect Behavior

7. Tax Reform Highlights
In 1981 Republicans passed the Economic Recovery Tax Act reducing taxes for individuals and businesses
In 1986, Congress passed a sweeping reform that established the alternative minimum tax.
In 1993, top marginal tax brackets of 36 and 39.6 percent were added to help the government drive down the deficit.
In 2001, tax law was revised to lower the top four marginal tax brackets by 2006, introduced a new 10 percent bracket, and eliminated the estate tax on the wealthiest 2 percent of taxpayers by
In 2003, the government accelerated many of the 2001 reforms and reduced the capital gains tax bracket.
In 2013, Democrats added two top tax brackets.

8. Establishing the Federal Budget
The president’s Office of Management and Budget prepares the federal budget and sends it to the House of Representatives.
There, it is divided into 13 categories and sent to subcommittees that prepare and vote on appropriations bills for them.
Approved bills go to the full Appropriations Committee and then to the entire House for a vote.
After the House has approved the budget, it is sent to the Senate, which may approve the House’s bill or draft another version; differences are worked out to create a compromise bill.
The approved bill is sent to the president for signature or veto. If signed, the budget becomes official for the next fiscal year, starting on October 1.
The size of the budget deficit or surplus changes significantly throughout the year due to unforeseen events.

9. Federal Government Revenue Sources
Our current income tax did not come about until the Sixteenth Amendment to the Constitution in 1913.
Income tax accounts for about one-third of all federal government revenue.
Borrowing by the federal government is a large source of revenue.
Payroll tax, or FICA, is levied on employers and employees equally to pay for Social Security and Medicare; this is another large source of income for the federal government.
The fourth-largest source of income is the corporate income tax.
Excise taxes are the fifth-largest source of federal revenue.
Estate and gift taxes account for a small fraction of total federal government revenue.
Other revenue sources include customs duties and miscellaneous fees such as user fees.

10. Federal Government Expenditures
Social Security payments make up the largest category of expenditures in the federal budget.
National defense spending is now the second-largest category of expenditures.
Income security includes transfer payments—payments for which the government receives neither goods nor services in return—for programs such as unemployment assistance, welfare, aid for people with disabilities, child care, foster care, Supplemental Security Income (SSI), subsidized housing, federal child support, Temporary Assistance for Needy Families (TANF), food stamps, and retirement benefits for federal civilian and military employees.
Medicare and Medicaid expenditures have risen dramatically as the population has aged and the cost of caring for the elderly has gone up.

11. From Deficits to Debt
Deficit spending is annual government spending in excess of revenues collected.
When the federal government has a deficit, it must finance the revenue shortage by borrowing, which creates the national debt.
The national debt has grown almost continuously since 1900.
Differences between public (national) and private debt include:
We owe most of the national debt to ourselves.
Instead of repaying debt, the government issues new bonds to pay off the old bonds.
The government does not give up purchasing power, except for the 34 percent of the public debt owed to foreigners.

12. Careless government spending can reduce private economic incentives.
Impact of the National Debt
National debt can cause a transfer of purchasing power from the private sector to the public sector.
Purchasing power is transferred from one generation to another when the government borrows today and leaves repayment to future taxpayers.
Careless government spending can reduce private economic incentives.
When the government competes with businesses and individuals for the supply of available loan funds, it can cause a crowding-out effect that results in higher-than- normal interest rates caused by heavy government borrowing.

13. Reducing Deficits and the Debt
There have been many failed attempts to reduce the deficit or balance the budget.
Another way to reduce a deficit is to raise revenues.
The 2001 terrorist attacks increased spending on homeland security and wars in Iraq and Afghanistan, resulting in record deficits in 2002.
Federal entitlements make spending difficult to reduce.
In 2011, the government agreed to a sequester that would start in 2013, requiring automatic and arbitrary budget cuts if Congress could not agree on significant reductions before then, which they did not.
The debt ceiling is the total amount of money the federal government is allowed to borrow; in 2013, an attempt to enforce the debt ceiling failed.

14. Chapter 14 Review and Practice
Answer questions 1 – 13 (Skip 6) on p 433 with your partner
For extra credit answer question 18 – 20 on p. 434