1. Copyright © 2002 by Thomson Learning, Inc. Chapter 10 Introduction to Government Finance Copyright © 2002 Thomson Learning, Inc. Thomson Learning™ is a trademark used herein under license. ALL RIGHTS RESERVED. Instructors of classes adopting PUBLIC FINANCE: A CONTEMPORARY APPLICATION OF THEORY TO POLICY, Seventh Edition by David N. Hyman as an assigned textbook may reproduce material from this publication for classroom use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage and retrieval systems—without the written permission of the publisher. Printed in the United States of America ISBN 0-03-033652-X

2. Copyright © 2002 by Thomson Learning, Inc. Plan  Présentation d’un système d’imposition  Critères d’évaluation d’un système d’impôt  Alternatives à l’impôt

3. Copyright © 2002 by Thomson Learning, Inc. Federal, State, and Local Revenue  Sources:  Taxes:  Payroll  Income (Corporate and Personal)  Property  Sales and Excise  Estate  Tariffs  Fees  Tuition  Licenses  $2.5 trillion

4. Copyright © 2002 by Thomson Learning, Inc. Determinants of How Much We Are Taxed  Political Equilibrium  Market Equilibrium and Its Efficiency  The Distribution of Income

5. Copyright © 2002 by Thomson Learning, Inc. Taxes  Taxes are compulsory payments to government

6. Copyright © 2002 by Thomson Learning, Inc. Tax Basics  Tax Base  The item or the activity that is to be taxed.  Tax Rate Structure  The relationship between the amount that is to be paid in tax and the tax base for a given accounting period.  Average Tax Rate  The total amount of tax divided by the total amount of the tax base.  Marginal Tax Rate  The amount by which the tax increases when the tax base increases.  Tax bracket  The range of the tax base in which the marginal rate is constant.

7. Copyright © 2002 by Thomson Learning, Inc. Descriptors of the Tax Rate Structure  A Progressive Tax has a structure where the marginal tax rate is increasing and greater than the average tax rate.  A Proportional Tax has a structure where the marginal tax rate is constant and equal to the average tax rate.  A Regressive Tax has a structure where the marginal tax rate is decreasing and less than the average tax rate.

8. Copyright © 2002 by Thomson Learning, Inc. Figure 10.1 A Proportional Tax Rate Structure Tax Rate (Percent) Tax Base (Dollars per Year) 0 t ATR = MTR

9. Copyright © 2002 by Thomson Learning, Inc. Figure 10.2 A Progressive Tax Rate Structure Tax Rate (Percent) Tax Base (Dollars of Taxable Income per Year) 0 35 25 15 MTR ATR 4,00029,00070,000

10. Copyright © 2002 by Thomson Learning, Inc. Figure 10.3 An Example of a Regressive Tax Structure Tax Rate (Percent) Annual Labor Earnings perWorker 0 15.30 12.35 2.9 $100,000 MTR ATR $76,200

11. Copyright © 2002 by Thomson Learning, Inc. Average Tax Rates Tax Brackets (Taxable Income) Marginal Tax Rates (MTR) Beginning of Bracket End of Bracket 0-$4,000000 $4000-$29,00015011 $29,000-$70,000 251320 Above $70,000352034* Average Tax Rates in the US

12. Copyright © 2002 by Thomson Learning, Inc. Average Tax Rates Throughout the World 0 60 50 40 30 20 10 Tax Revenues as a Percent of GDP Denmark Sweden Czech Republic Finland Belgium Netherlands Luxembourg FrancePolandAustria Greece * Italy Norway Hungary Germany Ireland New Zealand Canada * Spain United Kingdom Switzerland Portugal Iceland Australia Japan United States * Turkey Korea Mexico

13. Copyright © 2002 by Thomson Learning, Inc. How Should the Burden of Government Be Financed  Benefit Principle  Those that benefit the most from a particular program should pay the most for that program (Lindahl Tax principle at work).  Ability-to-Pay Principle  Those who have the greatest ability to pay should be required to pay the most.

14. Copyright © 2002 by Thomson Learning, Inc. Criteria for Evaluating Alternative Methods of Government Finance  Equity  The distribution of the burden of government finance should coincide with commonly held notions of fairness and ability-to-pay.  Efficiency  The system of government finance should raise revenues with only a minimal loss in efficiency in the private sector.  Administrative ease  A government finance system should be relatively easy to administer in a consistent manner without excessive costs to collect, enforce, and comply with taxes and tax laws.

15. Copyright © 2002 by Thomson Learning, Inc. Tax Compliance and Evasion  Tax Evasion is the term for illegal ways of avoiding paying taxes. It is typically the result of not declaring income or overstating otherwise legal deductions.  Tax Avoidance is the term for the legal ways of avoiding paying taxes, typically the result of avoiding activities that are taxed, delaying the time in which taxes are owed, or taking an action designed to lower a tax burden.

16. Copyright © 2002 by Thomson Learning, Inc. Figure 10.4 Reducing Tax Evasion Cost and Benefit Unreported Income per Year (Dollars) 0D* 1 B MC MB 2 D* A MC MB = MTR Cost and Benefit Unreported Income per Year (Dollars) 0 MC 2 C MC 1 Cost and Benefit Unreported Income per Year (Dollars) 0 MB = MTR E 1 E E 2 E E1E1 MB 1 = MTR 1 D* 2 1 2

17. Copyright © 2002 by Thomson Learning, Inc. Alternatives to Taxation  Debt Finance is the means of financing expenditures through the issuing of bonds.  Inflationary Finance is the means of financing expenditures through the printing of money.

18. Copyright © 2002 by Thomson Learning, Inc. Figure 10.5 Inflationary Finance Guns per Year Butter per Year 0 B2B2 G2G2 G1G1 C I A T'B1B1 T

19. Copyright © 2002 by Thomson Learning, Inc. More alternatives to Taxation  Donations  Money (but more usually time) is voluntarily given to government. Military service or work in the Peace Corps can be considered a donation when the compensation is less than the market value of the time.  User Charges  Payments by users of the government service can be expected. Examples include tuition, fees paid to enter state parks, greens fees at publicly owned golf courses.  Earmarked Taxes  Taxes can be implemented to fund specific public goods. Examples include gasoline taxes and tolls designed to fund road and bridge repair.

20. Copyright © 2002 by Thomson Learning, Inc. Figure 10.6 User Charges and Efficiency Charges Trash Pickups per Year 0 Q* C* C* + S* MSB = MPB + MEB MPB MSC S* Z* Z

21. Copyright © 2002 by Thomson Learning, Inc. Figure 10.7 User Charges for a Congestible Government-Supplied Service User Charges (Cents per Mile) Vehicles per Mile per Hour 0 E1E1 20 E2E2 D 2 = MSB 2 D 1 = MSB 1 MSC 80100120150 E* N*

22. Copyright © 2002 by Thomson Learning, Inc. Government Enterprise  Local Utilities  Lotteries

23. Copyright © 2002 by Thomson Learning, Inc. User Charges and Efficiency  Roads and Bridges wear out when too much weight is concentrated on too few axles.  Tolls motivate the wrong behavior in that they tax per axle rather than on pounds per axle.  Estimates suggest that taxing pounds per axle and using the revenue to repair roads to a greater strength would pay for itself more than eight-fold.

24. Copyright © 2002 by Thomson Learning, Inc. State Lotteries  State Lotteries account for more than 3% of state revenues.  Evidence suggests that the lottery system is a regressive means of creating government revenue.