Transcript Ch16

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16-1
How Does the Government Acquire Revenue?
• Taxing the public
– Federal taxes
– State and local taxes
• Government borrowing
– Government borrows when it issues
government securities
• Government bonds
• Treasury notes
• Treasury bills
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Federal Taxes
16-3
Federal Personal Income Taxes
• Most important tax levied by federal
government
– Personal income tax brings in roughly 44
percent of total federal tax revenue
– Different tax rate is applied to different
increments of income
• In this case, taxable income is called the tax base
– Tax rate
» Percentage of tax base that must be paid to
government as tax
– Tax base
» Income, earnings, sales, property, or other valued
items that have tax rate applied to them
16-4
Capital Gains
• Net income received when asset is bought
at particular price and subsequently sold
at higher price
– One continual political issue is whether
capital gains should be taxed in same way as
other forms of income
• Since higher-income people tend to receive by far
more capital gains than low-income people, cutting
capital gains tax would largely benefit high-income
people
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Tax Breaks
• Exemptions
– Amounts of money for each household member that
can be deducted from household income before
personal income tax rates are applied
• Standard deduction
– Fixed amount of money that taxpayers can deduct
from taxable income when calculating personal
income taxes, if other deductions are not claimed
• Tax credits
– Amounts of money by which income taxes payable to
government can be directly reduced
• Person or business must meet certain criteria to be eligible
for credit
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Social Insurance
• Second-largest federal category of taxes is
for social insurance
– Also called payroll taxes; deducted directly
from paycheck or paid by employer to fund
various social insurance programs
• Social Security
• Medicare
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Excise Taxes and Estate Taxes
• Excise taxes
– Applied to purchase of specific goods or services
• Estate taxes
– Until recently, were levied only on highly valued
estates that were passed on to others as inheritance
• Because wealthy people own bulk of taxable estates, most of
benefit goes to nation’s wealthiest individuals
– President Bush proposed elimination of estate tax on
highly valued property, thereby returning billions of
dollars to the public
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State and Local Taxes
16-9
Sales Taxes
• Bring in second-largest share of state and
local tax revenue
• Levied on goods and services sold within
state, locality, or both
– Some states exempt some certain items;
others do not
• Tax base is market value of purchased
item
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Personal Income Taxes
• Usually levied at state (and sometimes
local) level
– In some states, different tax brackets and
rates, as at federal level
– In other states, one tax rate applies to all
people’s taxable income
• Often referred to as flat-rate tax
– Various exemptions, deductions, and credits
may apply to state personal income tax
systems as well as those at federal level
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Property Taxes
• Levied by local governments and bring in
highest percent of combined state and
local tax revenue
• Levied directly on owners of houses and
land; depend on value of this property
• Used to fund local public schools
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Effects of Taxes on the Macroeconomy
16-13
Effects of Taxes on the Macroeconomy (cont.)
• If government finances increased expenditures
through increased taxes, moderate expansion of
economy will occur
– Moderate expansion may be appropriate if economy
is operating at high level of capacity
• Too much expansion would put undesired upward pressure
on price level
• If goal of government is to substantially expand
economy, raising taxes to finance increased
expenditures is not most effective way to
proceed
– Preferable to finance increased expenditures by
government borrowing
16-14
Effects of Taxes on the Income Distribution
• When economists consider redistributive effect
of taxes, usually classify taxes according to
three basic types:
– Progressive tax
• Takes greater percentage of income from high-income
people than from low-income people
– Proportional tax
• Takes same percentage of income from people of all income
levels
– Regressive tax
• Takes greater percentage of income from low-income people
than from high-income people
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Progressive Taxes
• Prime example is rate structure of federal
personal income tax
– Progressive tax rate structure relies on
different income brackets
• Higher the person’s income, higher are the tax
rates applied to increments of income
– Higher-income individual pays larger percentage of his or
her income to government; lower-income individual pays
smaller percentage of his or her income
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Proportional Taxes
• Example of flat-rate personal income tax levied
by various state governments
• Some have proposed that flat rate income tax be
used at federal level as well
– Because flat-rate tax takes same percentage of
income from people of all income levels, it does not
redistribute income
– Bear in mind that proportionality of actual flat-rate
taxes will depend on existence of various
exemptions, deductions, and credits combined with
taxes
• Overall result may well be regressive tax
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Regressive Taxes
• Most taxes in our country are regressive
• Include:
–
–
–
–
Sales taxes
Most excise taxes
Property taxes
Social Security tax
• Because some of these taxes are not
levied directly on income, seeing why they
are regressive is sometimes difficult
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Sales Taxes
16-19
Sales Taxes (cont.)
• Although numbers are made up, provide realistic
results
– Low-income family spends larger percent of income
on taxable consumer goods
• Low-income families must spend income on necessities and
have little income left over for saving
• Higher-income families can afford to save larger share of
income, thereby “consuming” smaller share
– Because higher-income family does spend more money on
taxable goods, in absolute terms, it will also spend more money
on state sales tax, again in absolute terms
– When tax amounts are expressed as percentages of family
incomes, however, we see that lower-income family pays
higher percent of income on tax
» 5 percent sales tax results in lower-income family paying
higher percent of its income on tax
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Property Taxes and Excise Taxes
• Regressive for very similar reasons
– Low-income families tend to spend larger
percentage of income on goods covered by
excise taxes and on housing (either owned
housing or rental housing) than do higherincome families
• Assuming that property taxes are passed on to
renters in form of higher rent, low-income families
end up paying larger percentage of incomes on
excise and property taxes than do higher-income
families
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Social Security Tax
• Also highly regressive, but for different reasons
– Levied only on income earned by working: that is, on
wages and salaries
• Because lower-income families earn most income in form of
wages and salaries, all of this income is taxed
• Most income of high-income people may be in form of
interest, capital gains, dividends, and so on
– Therefore, most of their income may not be taxed for Social
Security purposes
– Also regressive in that they are assessed on earnings
only up to certain limit
• Beyond this limit, earnings are not taxed
– All income of low-income earners may be taxed, whereas some
of income of high-income earners may not be
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Social Security Tax (cont.)
•
As result of earnings limit and taxation of only work-earned income, lowincome families pay much larger share of income on Social Security tax
than do high-income families
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Effects of an Excise Tax in the Microeconomy
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Effects of an Excise Tax in the Microeconomy (cont.)
• As consequence of imposition of excise tax,
smaller quantity of product is produced and sold,
price is higher, and both consumers and
suppliers share burden of the tax
– Impact of tax that is felt by producers and consumers
• Consumers bear burden in form of higher prices paid for
product
• Producers bear burden in form of lower profits
– Burden need not be shared equally by these two groups
» If price of product upon which excise tax is imposed rose
substantially, perhaps even full amount of tax, consumers
would bear entire brunt of tax
16-25
Effects of the Property Tax in the Microeconomy
16-26
Effects of Government Borrowing
on the Macroeconomy
• If government is financing expenditures by
borrowing, taxes will not increase
– Significant economic expansion will occur
• Whether this result is desirable depends on state
of economy
– If economy is operating at high capacity, expansion is
most likely to bring unwanted price rises in its wake
– If economy is operating well below capacity and perhaps
is in recession, expansion is exactly what doctor ordered
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Effects of Government Borrowing
on the Income Distribution
• Redistribution of income that occurs when
people buy government bonds may cause
greater income inequality in our country
– Bond owners tend to be middle- to upperincome people; rarely do low-income people
have means to participate in this type of
investment activity
• To extent that low-income people bear greater
burden of tax payments, and high-income people
receive greater benefit from interest receipts,
income redistribution occurs from poor to rich
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Effects of Government Borrowing
on Interest Rates
• Interest rate
– Percentage of borrowed funds that must be
paid to lender (or investor) for privilege of
using funds
• Can analyze impact of government
borrowing on interest rates if we view
market interest rates as simply price of
loanable funds
– Money that is borrowed and lent
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Effects of Government Borrowing
on Interest Rates (cont.)
16-30
Effects of Government Borrowing
on Interest Rates (cont.)
• As result of government borrowing, interest rates
go up
– Amount depends on state of economy and market for
loanable funds
• Most serious concern about rising interest rates
is impact on business and consumer spending
– When interest rates are high, less willing and able to
pay higher costs of borrowing
• Economists refer to this situation as crowding out
– Government spending, financed by borrowing, causes interest
rates to rise, which results in less spending by private economy
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Effects of Government Borrowing on the
Government Budget and the National Debt
• Budget deficit
– Difference between federal government spending and federal
government tax revenue in any one year
• Budget surplus
– Difference between federal government tax revenue and federal
government spending in any one year
• National debt
– Total amount of money owed by federal government
– Represents accumulation of all funds borrowed by federal
government that have not yet been repaid
• Budget deficit in any one year will increase size of national debt
(whereas budget surplus will decrease national debt)
• Government can continue to borrow indefinitely
– With no limit on borrowing, government can continually “roll over”
its debt; that is, it can continue to borrow money to repay
previously borrowed money
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The Size of the National Debt
• When considering size of budget deficit,
as well as size of national debt, inflation
must be considered
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The Size of the National Debt (cont.)
•
If we wish to accurately consider growing size of budget deficit or national
debt, we must consider size of variable relative to GDP
16-34
Who Owns the National Debt?
16-35
A Balanced Budget
•
•
•
Annually balanced budget would mean no government
borrowing, hence no addition to national debt
Would mean that all government expenditures must be
financed by tax revenue and that any government
spending increase must be matched by increase in tax
revenue
Economists see many problems with requirement that
federal government balance its budget:
1. Too many variables are unknown
2. No way to comply with balanced budget amendment if
recession were to occur
•
Only way government can correct recession is to increase its
spending or decrease taxes
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The Economic Left and the Economic Right
• THE ECONOMIC LEFT
(Liberal)
– More comfortable with
government taxes and
spending, as long as taxes do
not heavily burden poor and
middle class
– Like to use tax credits to
support what they consider
worthwhile activity, such as
spending on higher education
or care of elderly people
– Prefer spending for domestic
social programs
– Tend to be uncomfortable with
government borrowing to
support large defense
spending and tax cuts
• THE ECONOMIC RIGHT
(Conservative)
– Generally favor reductions in
government taxes
– Concerned that attendant
increases in interest rates will
crowd out private spending
– Worry about increased
government spending that
government borrowing permits
– Have strongly and publicly
argued in favor of legislation or
constitutional amendment that
requires balanced budget
– Seem relatively untroubled by
budget deficits as long as they
are caused by defense
spending and tax cuts
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Appendix: The Impact of Excise Taxes
with Perfectly Inelastic Demand
•
Perfectly inelastic demand
– Demand in which buyers are completely unresponsive to changes in
price
16-38
Appendix: The Impact of Excise Taxes
with Perfectly Inelastic Supply
•
Perfectly inelastic supply
– Supply in which producers are completely unresponsive to changes in
price
16-39
Appendix: The Impact of Excise Taxes with
Perfectly Inelastic Demand and Supply
•
Results of these two cases can be generalized
in a number of respects:
1. Group—be it consumers or producers—that is more
unresponsive (inelastic) to price changes bears
greater burden of any excise tax
2. Applies to any situation in which production costs
increase
•
When rising costs of production cause decrease in supply,
price will rise by some amount that depends on relative
elasticity of demand and supply
– More inelastic the demand, more the increased cost will be
passed on to consumers in form of increased prices
– More inelastic the supply, more the cost will be borne by
producers in form of lower profits, and the less probably it is
that prices will rise very much
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