1. Chapter 30 FINANCING GOVERNMENT Taxes and Debt Gottheil — Principles of Economics, 7e © 2013 Cengage Learning 1

2. Economic Principles © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 2 Commandeering resources Commandeering money (taxes) Regressive, proportional, and progressive tax structures

3. Economic Principles © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 3 Social Security taxes Government securities and public debt Internally and externally financing the debt

4. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 4 EXHIBIT 1PRODUCTION POSSIBILITIES CURVE

5. Exhibit 1: Production Possibilities Curve © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 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.

6. Commandeering Resources © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 6 What is the most direct method available for a government to acquire resources? The most direct method is to commandeer resources.

7. Commandeering Resources © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 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.

8. Commandeering Resources © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 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.

9. The Tax System © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 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.

10. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 10 Poll tax A tax of a specific absolute sum levied on every person or every household.

11. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 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.

12. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 12 1.What is an example of a regressive income tax? One example is a poll tax.

13. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 13 1.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.

14. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 14 Proportional income tax A tax that is a fixed percentage of income, regardless of the level of income.

15. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 15 2.An example of a proportionate income tax is? A flat-rate tax on personal income

16. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 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.

17. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 17 3.What is an example of a progressive income tax? The current system of federal income taxation is progressive.

18. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 18 Corporate income tax A tax levied on a corporation’s income before dividends are distributed to stockholders.

19. Are We Really Paying High Taxes? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 19 True or false: Taxes as a percentage of GDP are higher in the U.S. than in any other rich industrialized country. False

20. Are We Really Paying High Taxes? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 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.

21. Are We Really Paying High Taxes? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 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.

22. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 22 Property tax A tax levied on the value of physical assets such as land, or financial assets such as stocks and bonds.

23. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 23 Unit tax A fixed tax in the form of cents or dollars per unit, levied on a good or service.

24. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 24 Sales tax A tax levied in the form of a specific percentage of the value of the good or service.

25. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 25 Customs duty A sales tax applied to a foreign good or service.

26. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 26 Excise tax Any tax levied on a good or service, such as a unit tax, a sales tax, or a customs duty.

27. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 27 4.Complete the following sentence: All excise taxes are ______.

28. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 28 4.Complete the following sentence: All excise taxes are regressive.

29. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 29 5. 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

30. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 30 5.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

31. There’s More Than One Way to Levy Taxes © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 31 6.True or false: In any given year, Social Security taxes collected by the government equal the Social Security payments that the government makes. False. The surplus funds are invested in government bonds, which pay interest to the Social Security system.

32. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 32 EXHIBIT 22006 TAX RATE SCHEDULE FOR MARRIED PERSONS FILING JOINTLY Source: Internal Revenue Service, Instructions for Form 1040 (Washington, D.C.: Department of the Treasury, 2006).

33. Exhibit 2: 2006 Tax Rate Schedule for Married Persons Filing Jointly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 33 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.

34. Exhibit 2: 2006 Tax Rate Schedule for Married Persons Filing Jointly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 34 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?

35. Exhibit 2: 2006 Tax Rate Schedule for Married Persons Filing Jointly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 35 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?

36. Exhibit 2: 2000 Tax Rate Schedule for Married Persons Filing Jointly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 36 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?

37. Exhibit 2: 2006 Tax Rate Schedule for Married Persons Filing Jointly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 37 Thus the married couple pays a total of $(700 + $3210 + $10,100 + 8,736) = $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?

38. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 38 EXHIBIT 3FEDERAL, STATE, AND LOCAL GOVERNMENT REVENUES: 2007 ($ BILLIONS) Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, August 2008).

39. Exhibit 3: Federal, State, and Local Government Revenues: 2007 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 39 Complete the sentence: ______ taxes are the largest single source of combined government tax revenues.

40. Exhibit 3: Federal, State, and Local Government Revenues: 2007 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 40 Complete the sentence: Income taxes are the largest single source of combined government tax revenues.

41. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 41 EXHIBIT 4FEDERAL GOVERNMENT’S SURPLUSES AND DEFICITS AND AS PERCENT OF GDP: 1990–2007 (in constant 2000$) Source: Statistical Abstract, The United States: 2006 (Washington, D.C.: U.S. Department of Commerce, 2008).

42. Exhibit 4: Federal Government’s Surpluses and Deficits and as Percent of GDP: 1990–2007 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 42 True or false: The federal government ran a budget surplus during the years between 1990 and 2007. False. The federal government ran a budget deficit during that time period.

43. Financing Government Spending Through Debt © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 43 Public debt The total value of government securities— Treasury bills, notes, and bonds—held by individuals, businesses, other government agencies, and the Federal Reserve.

44. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 44 EXHIBIT 5OWNERSHIP OF THE U.S. PUBLIC DEBT: 2010 (percentage of total) Source: Federal Reserve Bulletin (Washington, D.C., September 2011).

45. Exhibit 5: Ownership of the U.S. Public Debt: 2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 45 Which of the following correctly identifies the top two owners of the U.S. public debt: a.Depository institutions b.Federal Reserves and intergovernmental holdings c.Foreigners

46. Exhibit 5: Ownership of the U.S. Public Debt: 2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 46 Which of the following correctly identifies the top two owners of the U.S. public debt: a.Depository institutions b.Federal Reserves and intergovernmental holdings and foreigners c.Pension funds

47. Financing Government Sending through Debt © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 47 Which form of federal government debt is sold in denominations as low as $1,000 and carry maturities of 2 to 10 years? U.S. Treasury notes

48. Tracking Government Debt © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 48 What caused gross federal debt to more than double between the early 1980s and the early 1990s ? Tax cuts in 1981 and again in 1986 Rising government spending in the 1980s Recessions in the early 1980s and again in the early 1990s

49. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 49 EXHIBIT 6ATHE FEDERAL DEBT Source: Statistical Abstract of the United States, 2006 (Washington, D.C.: U.S. Department of Commerce, 2006).

50. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 50 EXHIBIT 6BTHE FEDERAL DEBT Source: Statistical Abstract of the United States, 2006 (Washington, D.C.: U.S. Department of Commerce, 2006).

51. Exhibit 6: The Federal Debt © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 51 1.During what time period did the gross federal debt grow most rapidly? During the period between approximately 1980 and 2005

52. Exhibit 6: The Federal Debt © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 52 2. Based on the data in panel b of Exhibit 6, in what year was federal debt as a percentage of GDP the largest? 1945. Spending on the war effort caused federal debt to be 125 percent of GDP.

53. Exhibit 6: The Federal Debt © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 53 3.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.

54. Exhibit 6: The Federal Debt © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 54 4.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.

55. Exhibit 6: The Federal Debt © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 55 4.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.

56. Exhibit 6: The Federal Debt © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 56 4.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.

57. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 57 EXHIBIT 7GROSS PUBLIC DEBT AS A PERCENT OF GDP FOR SELECTED ECONOMIES: 2007 Source: The 2008 World Factbook, 2008.

58. Exhibit 7: Gross Public Debt as a Percent of GDP for Selected Economies: 2007 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 58 What does Exhibit 7 suggest about the U.S. debt ratio of 65.7 percent GDP compared to other countries? It is not out of line and even and is a near match of France’s and Germany’s.

59. Hatred of Tax Collection is the Way of the World © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 59 In which of the following countries do tax collectors wear commando uniforms and carry weapons: a.Sweden b.France c.Russia

60. Hatred of Tax Collection is the Way of the World © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 60 In which of the following countries do tax collectors wear commando uniforms and carry weapons: a.Sweden b.France c.Russia

61. Does Debt Endanger Future Generations? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 61 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.

62. Does Debt Endanger Future Generations? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 62 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.

63. Does Debt Endanger Future Generations? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 63 In addition, increased government debt purchased by the Fed will increase the money supply, which can be inflationary.

64. Does Debt Endanger Future Generations? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 64 Another problem with increased government debt is that it tends to crowd out private investment, which slows the rate of economic growth.

65. Does Debt Endanger Future Generations? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 65 External debt Public debt held by foreigners.

66. Does Debt Endanger Future Generations? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 66 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.

67. Are Deficits and Debt Inevitable? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 67 What was the impact of the Reagan tax agenda in the 1980s on the federal budget deficit? Supply-side advocates convinced Reagan that cutting tax rates would cause GDP to grow so much that tax revenues would actually increase.

68. Are Deficits and Debt Inevitable? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 68 What was the impact of the Reagan tax agenda in the 1980s on the federal budget deficit? Supply-side expectations notwithstanding, the tax reforms did not do much to increase tax revenues during the 1980s. At the same time, government spending continued to grow.

69. Are Deficits and Debt Inevitable? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 69 What was the impact of the Reagan tax agenda in the 1980s on the federal budget deficit? The combination of tax cuts and government spending growth produced in the 1980s the largest annual budget deficits in the history of the United States.

70. Are Deficits and Debt Inevitable? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 70 The combination of the Clinton presidency, the Republican Congress, and sustained economic growth eliminated budget deficits by the late-1990s.

71. Are Deficits and Debt Inevitable? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 71 Bush’s Jobs and Growth Tax Relief Reconciliation Act may have helped alleviate the post-1990s recession and the 9/11 downturn. However, budget deficits returned.

72. The Aftermath of the 2008 Financial Meltdown © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 72 The president, aided by an obliging Congress, sought to pull the economy out of its doldrums by incurring record-setting deficits which raised the public debt level above $13 trillion by 2010.