1. Introduction to Government Finance
Chapter 10
Introduction to Government Finance

2. Federal, State, and Local Revenue
Learning Objectives
Alternative means of financing government expenditures
Analysis of tax impacts on the economy and its criteria for evaluation
Alternative taxation methods

3. Alternative Means of Financing Government Expenditure
Alternatives are influenced by the following factors:
Political Equilibrium (e.g. voting)
Market Equilibrium and Its Efficiency (e.g. subsidies & taxation)
The Distribution of Income (e.g. equity)

4. Alternative Means of Financing Government Expenditure
Sources:
Taxes:
Payroll
Income (Corporate and Personal)
Property
Sales and Excise
Estate
Tariffs
Fees
Tuition
Licenses
$3 trillion annually!!

5. Alternative Means of Financing Government Expenditure
What are taxes? Taxes are compulsory payments to government
Tax Base
Tax Rate Structure
Marginal vs. Average
Progressive, Proportional & Regressive

6. Tax Basics Tax Base The item or activity that is to be taxed
General – no exclusions or exceptions
Selective – allows exceptions or deductions
Excise - selective tax on targeted goods
What are some examples?

7. Tax Basics Tax Rate Structure
The relationship between the amount that is to be paid in tax and the tax base for a given accounting period
Marginal Tax Rate - The amount by which the tax increases when the tax base increases

8. Tax Basics 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

9. Tax Basics Tax Rate Structure
The relationship between the amount that is to be paid in tax and the tax base for a given accounting period
Tax bracket - The range of the tax base in which the marginal rate is constant
Current Tax Code

10. Tax Basics Tax Rate Structure
Progressive Tax is where the marginal tax rate is increasing and greater than the average tax rate.
Proportional Tax is where the marginal tax rate is constant and equal to the average tax rate. (Sometimes called a Flat Tax)
Regressive Tax is where the marginal tax rate is decreasing and less than the average tax rate.

11. Figure 10.1 A Proportional Tax Rate Structure
ATR = MTR t
Tax Rate (Percent)
Flat Tax
Tax Base (Dollars per Year)

12. Figure 10.2 A Progressive Tax Rate Structure
MTR 35
ATR 25
Tax Rate (Percent)
Income Tax
(Current Structure) 15
4,000
29,000
70,000
Tax Base (Dollars of Taxable Income per Year)

13. Figure 10.3 An Example of a Regressive Tax Structure
15.30
Social Security Payroll Tax
12.35
Tax Rate (Percent) AT R
2.9
MTR
$76,200
$100,000
Ann
ual Labor Earnings per W
ork er

14. Average Tax Rates Throughout the World

15. How Should the Burden of Government Be Financed?
Benefit Principle
Those who 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.
Equity vs. Efficiency

16. Criteria for Evaluating Methods of Government Finance
Equity
The distribution of the government finance burden should coincide with commonly held notions of fairness and ability-to-pay. 
Efficiency
The system of government finance should raise revenues with the least loss in efficiency in the private sector. 
Administrative Ease (Efficiency)
A government finance system should be relatively easy to administer consistently, without excessive costs to collect, enforce, and comply with taxes and tax laws.

17. Tax Compliance, Avoidance and Evasion
Tax Evasion is the term for illegal ways to avoid paying taxes. It is typically the result of not declaring income or overstating otherwise legal deductions. 
Tax Avoidance is the term for legal ways to avoid paying taxes, typically the result of avoiding activities that are taxed, delaying the time at which taxes are owed, or taking an action designed to lower a tax burden.

18. Figure 10.4 Reducing Tax EvasionMC
MB = MTR
Cost and Benefit
Unreported Income per Year (Dollars) E
Cost and Benefit
Unreported Income per Year (Dollars) D* 1 B MC E
MB1 = MTR1 2
MB2 E2 D* C
MC1
Cost and Benefit
Unreported Income per Year (Dollars)
MB = MTR E1 D* 1 2
MC2 E D*
Reduce tax evasion by increasing its MC or reduce its MB!

19. Alternatives to Taxation
Debt Finance is the means of financing expenditures by issuing bonds.
Intergenerational
Inflationary Finance is the means of financing expenditures through the printing of money.
Winners vs.Losers

20. More Alternatives to Taxation
User Charges
Users of a government service can expect to pay for that service. 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.

21. Figure 10.6 User Charges and Efficiency
Trash Pickups per Year
MSB = MPB + MEB
MPB
MSC C*
C* + S* Z* Q* S* Z
S* = Subsidy Via Taxes

22. User Charges and the Transportation Infrastructure (Group Discussion)
Why voters always demand better roads and airports (even though their tax will go up)….
MPB > MPC ?

23. Figure 10.7 User Charges for a Congestible Government-Supplied Service
User Charges (Cents per Mile)
Vehicles per Mile per Hour
MSC
100 N*
What if the toll is $0? Given D1 shifts to D2 20
D2 = MSB2
120 E* E1
D1 = MSB1 80 E2
150

24. Why Not State Lotteries
38 states run or participate in lotteries.
State Lotteries account for more than 3% of state revenues.
People of varying incomes spend approximately the same amount on lotteries, which suggests that the lottery system is a regressive means of creating government revenue.
Lotteries pay out a smaller portion of revenue to winners than other forms of gaming (horse racing, casinos, etc.).