1. 16 Public Finance: Expenditures and Taxes McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. LO1 Government and the Circular Flow (1) Costs RESOURCE MARKET PRODUCT MARKET BUSINESSES H OUSEHOLDS (4) Goods and services (7) Expenditures (8) Resources (9) Goods and services (4) Goods and services (10) Goods and services Net taxes (12) Net taxes (11) (3) Consumption expenditures (3) Revenues GOVERNMENT (1) Money income (rents, wages, interest, profits) (2) Land, labor, capital Entrepreneurial Ability (2) Resources (5) Expenditures(6) Goods and services 16-2

3. LO1 Government Finance Government purchases Exhaustive Transfer payments Nonexhaustive Borrowing and deficit spending Opportunity cost is low during recession; high during growth 16-3

4. 20% 40 35 30 25 20 15 10 5 0 2009 1960 Government Purchases Government transfer payments 22% 15% 5% Year Percentage of U.S. output LO1 Government Finance Government purchases, transfers, and total spending as percentages of U.S. output 16-4

5. LO1 Global Perspective 16-5

6. LO1 Federal Expenditures 16-6

7. LO1 Personal income tax Progressive tax Marginal tax rate Payroll taxes Corporate income tax Excise taxes Federal Tax Revenues 16-7

8. Federal Tax Revenues LO1 (1) Total Taxable Income (2) Marginal Tax Rate % (3) Total Tax on Highest Income in Bracket (4) Average Tax Rate on Highest Income in Bracket % (3) / (1) $1-$16,75010$ 1,67510 $16,751-$68,000159,36314 $68,001-$137,3002526,68819 $137,301-$209,2502846,83422 $209,251-373,65033101,08627 Over $373,65035 Federal Personal Tax Rates, 2010* * For a married couple filing a joint return 16-8

9. LO1 State Finances 16-9

10. LO1 Local Finances 16-10

11. LO1 Local, State, and Federal Employment 16-11

12. LO2 Apportioning the Tax Burden Size, distribution, and impact of the costs that taxes impose on society Benefits-received principle Ability-to-pay principle 16-12

13. LO2 Apportioning the Tax Burden Progressive tax – average tax rates increase as income increases Regressive tax – average tax rate declines as income increases Proportional tax – average rate stays the same as income increases 16-13

14. LO2 Apportioning the Tax Burden Applications Personal income tax: progressive Sales tax: regressive Corporate tax: proportional Payroll tax: regressive 16-14

15. Tax incidence Who really pays the tax? Excise tax Tax burden depends on elasticity Inelastic vs. elastic Efficiency loss Deadweight loss Transfer of surplus to government Tax Incidence and Efficiency Loss LO3 16-15

16. Elasticity and Tax Incidence 14 12 10 8 6 4 2 0 510152025 Q P Price (Per Bottle) Quantity (Millions of Bottles Per Month) S D StSt Tax $2 LO3 16-16

17. LO3 Elastic Demand Inelastic Supply Tax a b c a b 0 Q2Q2 P1P1 Q1Q1 P PePe Smaller efficiency loss with inelastic demand StSt S DeDe DiDi c S Tax StSt P1P1 P PbPb Q2Q2 Q1Q1 PaPa P Elasticity and Tax Incidence 16-17

18. Elastic SupplyInelastic Supply Smaller efficiency loss with inelastic supply D D S SStSt StSt P1P1 PaPa PePe P1P1 PbPb PiPi Q1Q1 Q2Q2 Q1Q1 Q2Q2 Tax a a b b c c LO3 Elasticity and Tax Incidence 0 P P 0 Q Q 16-18

19. Efficiency Loss of a Tax Price (Per Bottle) Quantity (Millions of Bottles Per Month) S D StSt Tax $2 Tax paid by consumers 510152025 Q P 14 12 10 8 6 4 2 0 Tax paid by producers Efficiency loss (or deadweight loss) LO3 16-19

20. LO3 Global Perspective 16-20

21. LO3 Type of taxProbable Incidence Personal income tax Tax falls on the household or individual on which it is levied Payroll taxesWorkers pay the full tax levied on their earnings and part of the tax levied on their employers Corporate income tax Short Run: Full tax falls on owners of the businesses Long Run: Some of the tax may be born by workers through lower wages Sales taxTax falls on consumers who buy the taxed products Specific excise taxes Taxes fall on consumers, producers or both, depending on elasticity of supply and demand Property TaxesTaxes fall on owners in the case of land and owner occupied residences, tenants in the case of rented property, consumers in the case of business property Probable Incidence of U.S. Taxes 16-21

22. LO4 Distribution of income Taxes taken from the rich Do they to flow to the poor? Shows income is transferred to the poor Bottom 40% received more government spending than they paid in taxes Top 40% paid more in taxes than they received in government spending Redistribution vs. Recycling 16-22

23. LO4 Redistribution vs. Recycling 16-23