Transcript Principles of Economics Third Edition by Fred Gottheil

Chapter 30
Financing Government:
Taxes and Debt
© 2005 Thomson
Economic Principles
Commandeering resources
Commandeering money (taxes)
Regressive, proportional, and
progressive tax structures
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Economic Principles
Social Security taxes
Government securities and
public debt
Internally and externally
financing the debt
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EXHIBIT 1 PRODUCTION POSSIBILITIES CURVE
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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.
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Commandeering Resources
What is the most direct method
available for a government to
acquire resources?
• The most direct method is to commandeer
resources.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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
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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.
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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.
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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.
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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
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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.
•Tax revenues in the U.S. were 34.3 percent
of GDP.
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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.
• 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.
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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.
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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.
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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.
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There’s More Than One Way
to Levy Taxes
Customs duty
• A sales tax applied to a foreign good or
service.
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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.
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There’s More Than One Way
to Levy Taxes
4. Complete the following
sentence:
All excise taxes are ______.
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There’s More Than One Way
to Levy Taxes
4. Complete the following
sentence:
All excise taxes are regressive.
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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.
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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.
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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.
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EXHIBIT 2 2003 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.
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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.
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Exhibit 2: 2000 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 next $21,400 they pay 15%, which
equals $3,200.
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Exhibit 2: 2000 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?
10100
• On the next $40,400 they pay 25%, which
equals $10,100.
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Exhibit 2: 2000 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?
10100
• On the final $31,100 they pay 28%, which
equals $10,296.
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Exhibit 2: 2000 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?
• Thus the married couple pays a total of
$(700 + $3210 + $10,100 + 8,736) = $22,746.
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EXHIBIT 3 FEDERAL, STATE, AND LOCAL GOVERNMENT
REVENUES: 2002 ($ BILLIONS)
Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, October 2003).
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Exhibit 3: Federal, State, and Local
Government Revenues: 2002 ($ billions)
Complete the sentence:
______ taxes are the largest single
source of combined government
tax revenues.
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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.
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EXHIBIT 4 THE 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),
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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.
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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.
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EXHIBIT 5 OWNERSHIP OF THE U.S. PUBLIC DEBT: 2002
(PERCENTAGE OF TOTAL)
*Savings and loan associations, nonprofit institutions, credit unions,
certain U.S. Treasury deposit accounts, and federally sponsored agencies.
Source: Federal Reserve Bulletin (Washington, D.C., October 2003).
mutual
savings
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banks,
corporate
pension
trust
funds,
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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.
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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.
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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
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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.
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EXHIBIT 6A THE FEDERAL DEBT
Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).
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EXHIBIT 6B THE FEDERAL DEBT
Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).
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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.
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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.
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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.
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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.
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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.
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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.
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EXHIBIT 7
GROSS 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.
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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
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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
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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.
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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.
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Does Debt Endanger Future
Generations?
In addition, increased government
debt purchased by the Fed will
increase the money supply, which
can be inflationary.
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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.
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Does Debt Endanger Future
Generations?
External debt
• Public debt held by foreigners.
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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.
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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.
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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.
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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.
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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.
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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.
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