1. Ch. 11: More On government Spending and Taxes: Beyond Fiscal Policy Del Mar College John Daly ©2003 South-Western Publishing, A Division of Thomson Learning

2. Major Spending Programs Functions of Government include –Economic stabilization –Protection –Allocation –Distribution Where Does the Government Get the Money it Spends?

3. Major Federal Taxes Personal Income TaxPersonal Income Tax: paid on a person’s taxable income. Taxable income is income minus any exemptions and deductions. Corporate Income TaxCorporate Income Tax: paid on a corporation’s profits Social Security TaxSocial Security Tax: paid from a person’s income and from an employer.

4. Major Federal Taxes (Graph)

5. Income Tax Structure Progressive Income Tax: the tax rate increases as a person’s taxable income level rises. A progressive tax is usually capped at some tax rate. Proportionate Income Tax: the same tax rate is used for all levels. This is sometimes called a flat tax. Regressive Income Tax: the tax rate decreases as a person’s taxable income level rises.

6. Progressive Income Taxes and Equal After-Tax Pay For Equal Work The idea of Equal Pay for Equal Work often arises in discussions comparing jobs performed by both men and women. Sometimes, this idea is extended to equal after-tax pay for equal work. The progressive income tax structure can turn equal pay for equal work into unequal after-tax pay for equal work.

7. Who Pays Most of the Federal Individual Income Tax? Income GroupAverage Income Tax Rate Average Income Tax Paid All Taxpayers13.8%$ 4,998 Top 1%28.5150,788 Top 5%23.448,758 Top 10%20.830,249 Top 25%17.516,050 Top 50%15.49,534 Bottom 50%4.4462

8. Who Pays Most of the Federal Individual Income Tax? Income Group% Share of Total Income % Share of Federal Income Taxes Top 1%14.630.2 Top 5%28.848.8 Top 10%40.260.5 Top 25%63.480.3 Top 50%85.595.4 Bottom 50%14.54.6

9. National Consumption Tax and Value Added Tax A National Consumption Tax would be similar to a state sales tax except that it would be applied to all Americans. A Value-Added Tax (VAT) is essentially a multistage tax that is collected from firms at each stage in the production and distribution process. The base of a VAT is the value added to a good at each stage of its production. The value added is equal to the price a firm receives for a good minus its purchases of material inputs from other firms.

10. Q & A Explain the differences among progressive, proportional, and regressive income tax structure. What federal taxes together accounted for 91.9 % of all government receipts in 1999? Is a progressive income tax at times inconsistent with both equal pay for equal work and equal after-tax pay for equal work?

11. Major Government Spending Programs National Defense Income Security Health Medicare Social Security Net Interest on the Public Debt. Other

12. Mandatory Vs. Discretionary Spending Mandatory spending can be viewed as automatic spending or spending that is not subject to annual review. Discretionary spending is spending subject to annual review. In 1969, 70% of all federal spending was discretionary. In 1999, 26% of all federal funding was discretionary.

13. Q & A In 1999, what percentage of federal government spending went for net interest on the public debt, Social Security, and Medicare (combined)? What is the difference between mandatory spending and discretionary spending?

14. Deficits and the Public Debt Public debt is the total amount the federal government owes its creditors. Cyclical deficit refers to that part of the budget deficit that is part of an economic downturn. The Structural deficit is the remainder of the budget deficit that would exist if the economy were operating at full employment.

15. Why know the Difference between Structural and Cyclical Deficit? We must focus on structural deficit to get a correct reading of fiscal policy.

16. The Size and Type of Deficit Two important matters were: the size of the deficit and how it was measured. Currently, the revenues from Social Security taxes are greater than the benefits paid – meaning the Social Security System has a surplus. In 1998, there would not have been a budget surplus if an adjustment had been made for the Social Security surplus. In fact, there would have been a deficit.

17. The Size and Type of Deficit Eisner has argued the budget deficit that matters is the real budget deficit, not the nominal budget deficit. To obtain the real deficit, the public debt should be adjusted each year for inflation and then subtracted from the actual or nominal deficit. Real Budget Deficit = Nominal budget deficit – (Public debt X Inflation rate)

18. The Public Debt Is equal to the total amount the government owes its creditors. About 31 % of this debt was held by agencies of the US government – one agency owing money to another. The gross public debt is the entire debt, while the net public debt is the part (69% in 1999) held by the public.

19. The Public Debt

20. Who Bears the Burden of the Public Debt? The Current Generation Bears the Public Debt? The Future Generation Bears the Public Debt?

21. The Current Generation Bears the Public Debt? Public borrowing only imposes a burden on the current generation. The current generation must give up private goods to pay for the increased national defense, so the current generation bears the debt. If we lump both taxpayers and bondholders together and realize that together they make up future generations, the future generation doesn’t owe any debt, because paying the debt merely details the transfer of funds. But this doesn’t take into account current budget deficits reducing capitol investment by the current generation: It doesn’t take Crowding Out into account.

22. The Future Generation Bears the Public Debt? Although resources are drawn from the private sector when debt-financed public expenditures are made, the people who give up these resources do not pay for, or bear the burden of, the public expenditures secured. The bondholders have entered into a voluntary trade. They decide to consume a little less today in order to consume more (when the bonds are paid off). The bondholders do not gain anything since they are trading one asset (bonds) for another (money) of equal value and the taxpayers lose something: taxes to pay the bonds off.

23. Budget Surpluses There was also disagreement as to what should be done with the surpluses. Some wanted to “save Social Security”; although more money was going into Social Security than was being paid out, this was expected to end in the future. If budget deficits were translated into “higher future taxes”, then it follows that budget surpluses were translated into “lower future taxes.” The personal savings rate in the economy was near zero, and consumer spending was strong. Even though budget surpluses were being discussed, few Americans seemed exited by tax cuts.

24. Q & A How is the cyclical deficit computed? Suppose the nominal deficit is $100 billion, the inflation rate is 1%, and the public debt is $4,000 billion. What is the real budget deficit? Explain the argument that states the current generation bears the burden of the public debt. Explain how budget surpluses may be viewed as tax cuts. What is the unified budget?

25. Social Security: A Primer Social Security taxes are paid by both employees and employers. Medicare taxes are paid the same way. If a person earned more than $68,400 in 1999, he or she continued to pay the Medicare portion of the tax on all earnings. Social Security and Medicare taxes are divided among numerous trust funds. Two Social Security funds are OASI (Old Age & Survivors Insurance) trust fund used to pay retirement and survivor’s benefits. DI (Disability Insurance) is used to pay benefits to people with disabilities and their families.

26. Social Security: A Primer There are two Medicare trust funds: HI (Hospital Insurance) used to pay for the services under Part A of Medicare; SMI (Supplementary Medical Insurance) trust fund is to pay for the services under Part B of Medicare. Together these are referred to as the Medicare Trust Fund Every day tax revenues roll into these funds. The money is paid from these funds and any left over is invested daily in US government securities. The average monthly Social Security payment to a retired worker in 2002 is $874.

27. Social Security In the Future: The Numbers In 1965, Americans 65 and older made up 9% of the population. In 1995, they were 13% of the population. By 2030, they will be 20% of the population. In 1995 there were five workers contributing to Social Security taxes for every one Social Security beneficiary. In 2030, it is predicted that there will be five workers for every TWO Social Security beneficiaries. It is predicted by 2013, payroll taxes are expected to fall short of spending benefits.

28. Q & A What was the average monthly Social Security payment to a retired worker in 2002? What was the combined tax rate (for Social Security) in 2002? Social Security is a pay- as-you-go system. What does this mean?