1. Chapter 13: Government Spending, Taxing, and National Debt

2. Size of Government Government expenditures as a percentage of GDP have grown from 23% in 1960 to % in 199 Expenditures of Federal government have risen from 17% to % of the GDP between 1960 and 199

3. Components of Government Expenditures Government purchases of goods and services have remained stable at about 20% of the GDP in 1960-97 Transfer payments have grown from 6% to 1% of the GDP over this period

4. Taxes Tax revenues as a percentage of the GDP increased from 26% in 1960 to 30% in 1999 Federal tax receipts rose from 18% to 20% of the GDP over this period

5. Role of Government: Public Goods Non-rival in consumption: use by one person will not require loss of consumption by another person Non-exclusive: no one can be excluded from consumption once it is produced Free-rider problem: everyone uses regardless of tax payments

6. Role of Government: Externalities Benefits and costs of one’s consumption and production to third parties Positive externalities require government subsidies (college education) Negative externalities require government taxes or regulations (pollution)

7. Positive Externalities: MSB>MPB Price Quantity MPB P P’ QQ’ A MSB B MPC=MSC

8. Negative Externalities: MSC>MPC Price Quantity MSC P P’ Q’Q MPC B A MSB=MPB

9. Role of Government: Income Distribution Progressive taxation and transfer payments to bridge income gap between the rich & poor Horizontal equity: people with equal income pay equal amount of tax regardless the source of income Vertical equity: people with higher income pay larger taxes

10. Incidence of Tax: Inelastic Demand Quantity Price P1 Q1 D D S S P2 S’ Tax is paid by consumer: Forward shifting Tax

11. Incidence of Tax: Elastic Demand Price Quantity S’ P Q1 D D S S Q P1 Tax Tax paid by producer: Backward shifting

12. Comparative Data U.S. tax share of the GDP is 31.5% It is the smallest among industrial nations The highest share belongs to Denmark, 60%

13. Composition of Tax Receipts: 1950-2000 Individual income tax share rose from 39.9 to 47.8% Corporate income tax share fell from 26.5 to 10% Social security tax share rose from 11 to 33.8% Excise tax share fell from 19.1 to 3.7%

14. Effective Federal Income Tax Rates, 1996 Income bracket, $Tax rate, % Less than 10,0008.0 10,000 – 20,0008.8 20,000 – 30,00013.3 30,000 – 50,00017.5 50,000 – 70,00019.5 70,000 – 100,00021.1 100,000 – 200,00022.0 More than 200,00023.7

15. Federal Budget Account ($ billions) YearReceiptsSpendingBalance 19931,1541,409-255 19941,2591,462-201 19951,3521,516-114 19961,4531,561-108 19971,5791,601-22 19981,6581,668-10 19991,7431,802+69

16. Public Debt Government borrows money from investors through the issuance and sale of government securities or bonds Investors hold the bonds for a certain time period to make interest income

17. Government Securities Non-marketable securities –U.S. Savings Bonds & Notes: redeemable in cash for the face value after maturity Marketable securities –Treasury bills (< 1 year; low interest rate) –Treasury notes (1-5 years) –Treasury bonds (> 5 years, high interest rate)

18. National Debt Government borrowing to cover budget deficit Debt id owed to –Private investors –Banks and financial institutions –Insurance companies –State & local governments –Foreign governments and private investors

19. Budget & Debt YearBudget Surplus National Debt Debt Repayment In $ billions 1998695,47951 1999*795,61550 2000*1175,71298 2001*1345,781117 2002*1875,818170 * Estimates

20. Economic Effects of Federal Debt Primary burden: opportunity cost of servicing the debt in terms of reduced public investment Inflationary effect: higher interest rates and prices

21. Economic Effects of Federal Debt Income distribution effect: income transfer from government to high income investors Output effect: higher taxes and opportunity cost of productive investment