1. © 2005 Thomson C hapter 30 Financing Government: Taxes and Debt

2. © 2005 Thomson 2 Gottheil - Principles of Economics, 4e Economic Principles Commandeering resources Commandeering money (taxes) Regressive, proportional, and progressive tax structures

3. © 2005 Thomson 3 Gottheil - Principles of Economics, 4e Economic Principles Social Security taxes Government securities and public debt Internally and externally financing the debt

4. © 2005 Thomson 4 Gottheil - Principles of Economics, 4e EXHIBIT 1PRODUCTION POSSIBILITIES CURVE

5. © 2005 Thomson 5 Gottheil - Principles of Economics, 4e Exhibit 1: Production Possibilities Curve 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. © 2005 Thomson 6 Gottheil - Principles of Economics, 4e Commandeering Resources What is the most direct method available for a government to acquire resources? The most direct method is to commandeer resources.

7. © 2005 Thomson 7 Gottheil - Principles of Economics, 4e Commandeering Resources 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. © 2005 Thomson 8 Gottheil - Principles of Economics, 4e Commandeering Resources 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. © 2005 Thomson 9 Gottheil - Principles of Economics, 4e The Tax System 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. © 2005 Thomson 10 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes Poll tax A tax of a specific absolute sum levied on every person or every household.

11. © 2005 Thomson 11 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes 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. © 2005 Thomson 12 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes 1. What is an example of a regressive income tax? One example is a poll tax.

13. © 2005 Thomson 13 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes 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. © 2005 Thomson 14 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes Proportional income tax A tax that is a fixed percentage of income, regardless of the level of income.

15. © 2005 Thomson 15 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes 2. What is an example of a proportionate income tax? A flat-rate tax on personal income

16. © 2005 Thomson 16 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes 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. © 2005 Thomson 17 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes 3. What is an example of a progressive income tax? The current system of federal income taxation is progressive.

18. © 2005 Thomson 18 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes Corporate income tax A tax levied on a corporation’s income before dividends are distributed to stockholders.

19. © 2005 Thomson 19 Gottheil - Principles of Economics, 4e Are We Really Paying High Taxes? True or false: Taxes as a percentage of GDP are higher in the U.S. than in any other rich industrialized country. False

20. © 2005 Thomson 20 Gottheil - Principles of Economics, 4e Are We Really Paying High Taxes? 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. © 2005 Thomson 21 Are We Really Paying High Taxes? 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. © 2005 Thomson 22 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes Property tax A tax levied on the value of physical assets such as land, or financial assets such as stocks and bonds.

23. © 2005 Thomson 23 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes Unit tax A fixed tax in the form of cents or dollars per unit, levied on a good or service.

24. © 2005 Thomson 24 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes Sales tax A tax levied in the form of a specific percentage of the value of the good or service.

25. © 2005 Thomson 25 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes Customs duty A sales tax applied to a foreign good or service.

26. © 2005 Thomson 26 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes Excise tax Any tax levied on a good or service, such as a unit tax, a sales tax, or a customs duty.

27. © 2005 Thomson 27 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes 4. Complete the following sentence: All excise taxes are ______.

28. © 2005 Thomson 28 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes 4. Complete the following sentence: All excise taxes are regressive.

29. © 2005 Thomson 29 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes 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. © 2005 Thomson 30 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes 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. © 2005 Thomson 31 Gottheil - Principles of Economics, 4e There’s More Than One Way to Levy Taxes 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. During the late-1990s the government gathered more Social Security taxes than were paid to beneficiaries.

32. © 2005 Thomson 32 Gottheil - Principles of Economics, 4e EXHIBIT 22003 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.

33. © 2005 Thomson 33 Gottheil - Principles of Economics, 4e Exhibit 2: 2003 Tax Rate Schedule for Married Persons Filing Jointly 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. © 2005 Thomson 34 Gottheil - Principles of Economics, 4e Exhibit 2: 2000 Tax Rate Schedule for Married Persons Filing Jointly 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. © 2005 Thomson 35 Gottheil - Principles of Economics, 4e Exhibit 2: 2000 Tax Rate Schedule for Married Persons Filing Jointly 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

36. © 2005 Thomson 36 Gottheil - Principles of Economics, 4e Exhibit 2: 2000 Tax Rate Schedule for Married Persons Filing Jointly 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

37. © 2005 Thomson 37 Gottheil - Principles of Economics, 4e Exhibit 2: 2000 Tax Rate Schedule for Married Persons Filing Jointly 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. © 2005 Thomson 38 Gottheil - Principles of Economics, 4e EXHIBIT 3FEDERAL, STATE, AND LOCAL GOVERNMENT REVENUES: 2002 ($ BILLIONS) Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, October 2003).

39. © 2005 Thomson 39 Gottheil - Principles of Economics, 4e Exhibit 3: Federal, State, and Local Government Revenues: 2002 ($ billions) Complete the sentence: ______ taxes are the largest single source of combined government tax revenues.

40. © 2005 Thomson 40 Gottheil - Principles of Economics, 4e Exhibit 3: Federal, State, and Local Government Revenues: 2002 ($ billions) Complete the sentence: Income taxes are the largest single source of combined government tax revenues.

41. © 2005 Thomson 41 Gottheil - Principles of Economics, 4e EXHIBIT 4THE FEDERAL GOVERNMENT’S SURPLUSES AND DEFICITS: 1970–2002 ($ BILLIONS) Source: Economic Report of the President, 1997 (Washington, D.C.: U.S. Government Printing Office, 1997), p. 394, and Bureau of Economic Analysis, “Overview of the Economy.” 2000; and Survey of Current Business (Washington, DC: U.S. Department of Commerce, 2003),

42. © 2005 Thomson 42 Gottheil - Principles of Economics, 4e Exhibit 4: The Federal Government’s Surpluses and Deficits: 1970–2002 ($ billions) True or false: The federal government ran a budget surplus during the years between 1970 and 1995. False. The federal government ran a budget deficit during that time period.

43. © 2005 Thomson 43 Gottheil - Principles of Economics, 4e Financing Government Spending Through Debt 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. © 2005 Thomson 44 Gottheil - Principles of Economics, 4e 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).

45. © 2005 Thomson 45 Gottheil - Principles of Economics, 4e Exhibit 5: Ownership of the U.S. Public Debt: 2002 (percentage of total) Which of the following correctly identifies the top two owners of the U.S. public debt: a. The Federal Reserve and insurance companies. b. Federal agencies and trust funds, and foreigners. c. Commercial banks and individual U.S. citizens.

46. © 2005 Thomson 46 Gottheil - Principles of Economics, 4e Exhibit 5: Ownership of the U.S. Public Debt: 2000 (percentage of total) Which of the following correctly identifies the top two owners of the U.S. public debt: a. The Federal Reserve and insurance companies. b. Federal agencies and trust funds, and foreigners. c. Commercial banks and individual U.S. citizens.

47. © 2005 Thomson 47 Gottheil - Principles of Economics, 4e Financing Government Sending Through Debt Which form of federal government debt is sold in denominations as low as $1000 and carry maturities of 2 to 10 years? U.S. Treasury notes

48. © 2005 Thomson 48 Gottheil - Principles of Economics, 4e Tracking Government Debt 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. © 2005 Thomson 49 Gottheil - Principles of Economics, 4e EXHIBIT 6ATHE FEDERAL DEBT Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).

50. © 2005 Thomson 50 Gottheil - Principles of Economics, 4e EXHIBIT 6BTHE FEDERAL DEBT Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).

51. © 2005 Thomson 51 Gottheil - Principles of Economics, 4e Exhibit 6: The Federal Debt 1. During what time period did the gross federal debt grow most rapidly? During the period between approximately 1980 and 2000.

52. © 2005 Thomson 52 Gottheil - Principles of Economics, 4e Exhibit 6: The Federal Debt 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. © 2005 Thomson 53 Gottheil - Principles of Economics, 4e Exhibit 6: The Federal Debt 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. © 2005 Thomson 54 Gottheil - Principles of Economics, 4e Exhibit 6: The Federal Debt 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. © 2005 Thomson 55 Gottheil - Principles of Economics, 4e Exhibit 6: The Federal Debt 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. © 2005 Thomson 56 Gottheil - Principles of Economics, 4e Exhibit 6: The Federal Debt 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. © 2005 Thomson 57 Gottheil - Principles of Economics, 4e 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.

58. © 2005 Thomson 58 Gottheil - Principles of Economics, 4e Hatred of Tax Collection is the Way of the World In which of the following countries do tax collectors wear commando uniforms and carry weapons: a. Sweden b. France c. Russia

59. © 2005 Thomson 59 Gottheil - Principles of Economics, 4e Hatred of Tax Collection is the Way of the World In which of the following countries do tax collectors wear commando uniforms and carry weapons: a. Sweden b. France c. Russia

60. © 2005 Thomson 60 Gottheil - Principles of Economics, 4e Does Debt Endanger Future Generations? 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.

61. © 2005 Thomson 61 Gottheil - Principles of Economics, 4e Does Debt Endanger Future Generations? 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.

62. © 2005 Thomson 62 Gottheil - Principles of Economics, 4e Does Debt Endanger Future Generations? In addition, increased government debt purchased by the Fed will increase the money supply, which can be inflationary.

63. © 2005 Thomson 63 Gottheil - Principles of Economics, 4e Does Debt Endanger Future Generations? Another problem with increased government debt is that it tends to crowd out private investment, which slows the rate of economic growth.

64. © 2005 Thomson 64 Gottheil - Principles of Economics, 4e Does Debt Endanger Future Generations? External debt Public debt held by foreigners.

65. © 2005 Thomson 65 Gottheil - Principles of Economics, 4e Does Debt Endanger Future Generations? 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.

66. © 2005 Thomson 66 Gottheil - Principles of Economics, 4e Are Deficits and Debt Inevitable? 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.

67. © 2005 Thomson 67 Gottheil - Principles of Economics, 4e Are Deficits and Debt Inevitable? 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.

68. © 2005 Thomson 68 Gottheil - Principles of Economics, 4e Are Deficits and Debt Inevitable? 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.

69. © 2005 Thomson 69 Gottheil - Principles of Economics, 4e Are Deficits and Debt Inevitable? The combination of the Clinton presidency, the Republican Congress, and sustained economic growth eliminated budget deficits by the late-1990s.

70. © 2005 Thomson 70 Gottheil - Principles of Economics, 4e Are Deficits and Debt Inevitable? 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.