Transcript Payroll Tax - McGraw Hill Higher Education

The Government
Sector
Chapter 07
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives

After this chapter you should be able to:
1.
2.
3.
4.
5.
6.
7.
8.
Define and discuss federal, state, and local government
spending.
Analyze the graph of the C + I + G line.
Define and compute the average and marginal tax rates.
Identify and discuss the types of taxes.
List and discuss the sources of federal government revenue.
Summarize recent federal tax legislation.
List and discuss the sources of state and local government
revenue.
Explain and discuss the economic role of government.
7-2
Introduction: The Growing Economic Role of
Government


Most of the growth over the past 7 decades was due to
the Depression and WWII (1929 – 1945).
After 1945, the roles of government at the federal,
state, and local levels continued to expand.
•

When Ronald Reagan was elected in 1980, there was
a political swing in favor of shrinking the size of
government.
•

Americans were determined to avoid another Depression or
another military attack.
Reagan promised to “get the government off the backs of the
American people.”
In 2008 – 2009, as the economy sank into recession,
voters demanded the government do something.
•
$700 billion financial bailout and $787 billion stimulus
7-3
How Government Influences the Economy

The government exerts 4 basic influences over the
economy:
1.
2.
3.
4.
It spends trillions of dollars.

Public goods and services
It levies trillions of dollars in taxes.
It redistributes hundreds of billions of dollars.

To the poor, retirees, and the holders of government bonds
It regulates the economy.

Laws regulate how business may be conducted.
7-4
Federal Government Spending

The federal government’s financial, or fiscal, year begins
on October 1 and runs through September 30 of the
following year.
•
•
Preparation of the budget begins about two years before the
beginning of the fiscal year.
 President and the Office of Management and Budget (OMB)
work with departments and agencies on budget plans.
 The President submits the final budget message in February
of prior fiscal year.
 By May 15, both houses of Congress have to pass a
concurrent budget resolution.
 Appropriations bills are passed between May and October.
 The 13 spending bills that are the heart of the budget are
often passed late.
In fiscal year 2011 the federal government plans to spend about
7-5
Government Revenues and Spending,
Fiscal Year 2009
Source: Economic Report of the President, 2010;
http://www.whitehouse.gov/omb.
7-6
Spending: Past, Present, and Future
As a share of federal spending, Social Security, Medicare, and
Medicaid have more than doubled in 40 years and will continue to
grow, according to the Congressional Budget Office’s “intermediate”
projections.
Figures are from President Barack Obama’s 2011 budget. They are projected estimates
of actual spending.
Source: Congressional Budget Office.
7-7
Does the US spend too much on foreign aid?
This is less than 1% of the federal budget.
Source: OECD.
7-8
State and Local Government Spending

Main expenditures:
•
•
•
Education
Health
Welfare

Spending is a little more than half the level of federal
spending.

Police protection and prisons are now straining state and
local budgets.
7-9
Government Purchases versus Transfer
Payments

The federal, state, and local governments spends over
$5.0 trillion a year.
•
•
Approximately half are “government purchases.”
 The largest government purchase is defense.
 These end up in the “G” part of GDP.
 GDP = C + I + G + Xn
Approximately half are “transfer payments.”
 The largest transfer payment is social security.
 These payments end up in the “C” part GDP.
7-10
Graphing the C + I + G Line

Assume government spending is
constant across all levels of
disposable income at $2,000
billion (or $2 trillion).

We see how it shifts the function
up to the new C + I + G line.

This new line crosses the 45degree line at a new equilibrium
of $10 trillion.

We will add Xn in chapter 8.
7-11
Questions for Thought and Discussion

How did the Great Depression encourage the growth of
government?

Which categories of government spending would you like
to see decreased? Which would you like to see
increased?

Why do transfer payments show up in Consumption
rather than Government Purchases?
7-12
The Average Tax Rate and the Marginal Tax
Rate

The Average Tax Rate (ATR) is the overall rate you pay
on your entire income.

The Marginal Tax Rate (MTR) is the rate you pay on the
last dollars you earned.
•
Once again, “marginal” refers to the response to a change.
7-13
The Average Tax Rate and the Marginal
Tax Rate: A Hypothetical Illustration
Income
Level
Marginal
Tax Rate
0 – $100
0 %
$101 – $200
Tax
Total
Taxes
Average
Tax Rate
$0
$0
0.0 %
10 %
$10
$10
5.0 %
$201 – $300
12 %
$12
$22
7.3 %
$301 – $400
15 %
$15
$37
9.3 %
$401 – $500
28 %
$28
$65
13.0 %
$501 – $600
50 %
$50
$115
19.2 %
7-14
Types of Taxes

Direct tax
•
•
•

A tax with your name on it
Examples: personal income tax, social security payroll tax
Another example: corporate income tax on profits
Indirect tax
•
•
A tax on goods and services that we purchase.
Examples: sales taxes, excise taxes
7-15
Types of Taxes

Progressive taxes
•
•
•

Proportional taxes
•
•

As your income increases, the percentage that you pay
increases.
Places a greater burden on those best able to pay and little or no
burden on the poor.
Example: federal income tax
Flat tax (same percent with no deductions)
It would be much harder for a family with an income of $10,000 to
pay $1,500 in income tax (15 percent of $10,000) than it would be
for a family with an income of $100,000 to pay $15,000 (15
percent of $100,000).
Regressive taxes
•
•
Places a heavier burden on the poor than on the rich
Example: social security tax
7-16
Nominally Progressive, Proportional, &
Regressive Taxes
7-17
Sources of Federal Revenue

Personal Income Tax
•
•

Payroll Tax
•

Accounts for only 12% of federal tax revenue.
Excise Taxes
•
•

Social Security and Medicare taxes
Corporate Income Tax
•

The largest source (44%) of federal revenue.
Considered progressive because the burden falls mainly on the
upper middle class and the rich.
Sales tax aimed at specific goods and services. May be intended
to reduce consumption.
Examples: tires, cigarettes, liquor, gasoline, phone calls
Estate Tax
•
•
Tax on estates left to people other than spouse.
Phased out by end of 2009 but set to come back in 2011.
7-18
Federal Personal Income Tax: The Top
Marginal Tax Rate, 1993–2010
7-19
Top Marginal Combined Income Tax Rates in 11
Leading Wealthy Nations, 2008*
*Combined federal, state, and local income taxes.
Source: OECD.
7-20
Payroll Taxes



The Social Security and Medicare taxes are the Payroll
Tax.
 What you pay is matched by your employer.
The Social Security tax by law is set at 6.2% with a wage
based limitation of $106,800.
 The inflation rate of the previous year raises the
wage base.
The Medicare tax of 1.45% applies to all wages and
salaries.
•
There is no wage based limitation. Income such as rental income,
interest, dividends, and profit is exempt.
7-21
Payroll Taxes (Continued)

You pay 6.2% in payroll tax on wages up to $94,200
and 1.45% on all wages and salaries.
•


This means the rich whose income is primarily from rental
income, interest, dividends, and profits pay no payroll taxes
on money from these sources.
The Payroll Tax is the fastest growing source of
federal revenue.
• Today, 3/4th of all taxpayers pay more in social
security taxes than in federal income tax.
Think about it. . .only a tiny fraction of the income of
the rich goes to payroll taxes.
7-22
The Incidence of the Social Security Tax at
Various Income Levels in 2010
Note: The current social security tax by law is set at 6.2% with a wage
based limitation of $106,800.
7-23
The Estate Tax





The estate tax is a tax on the estates of people when
they die.
This tax expired on December 31, 2009.
The estates of those who died in 2010 paid no federal
taxes.
But on January 1, 2011, under the snap-back tax plan,
estates will once again be taxed at a rate of 55 percent of
everything over $1 million.
By the time you read this, it is likely that Congress will
have modified the tax to enable inheritors of farms and
other businesses to carry on without having to pay such a
high tax.
7-24
Recent Tax Legislation




Kemp-Roth Tax Cut of 1981
Tax Reform Act of 1986
Tax Cut of 2001
Tax Cut of 2003
7-25
Sources of State and Local Tax Revenue

Personal income tax
•

Sales Tax
•
•

Accounts for about half of all state revenue.
Is a source of almost half of all taxes collected by the states.
Is a highly regressive tax.
Property taxes
•
•
Provides 80% of all local tax revenue.
Can influence business decisions about where to locate.
7-26
The State and Local Fiscal Dilemma

Since WWII, state and local governments have been
expected to provide an increasing number of services.
•

Unfunded mandates
•
•

The Federal government often places obligations on states
without providing the money to pay for them.
Examples: NCLB, Homeland Security
Neighboring states and local governments are in direct
competition with one another for tax dollars.
•

Most notable are health, welfare, education, police protection
and prisons.
If one government’s tax rates rise too far above the levels of its
neighbors, it citizens will vote with their feet.
In response, states have increased tuition at public
colleges, cut Medicaid eligibility and benefits, and laid off
state employees.
7-27
Government Tax Rates as a Percentage
of GDP, 1929 and 2009
Since 1929 Federal
taxes have risen
much more quickly
than state and
local taxes as a
percentage of GDP.
Source: Economic Report of the President, 2010;
Survey of Current Business, March 2010,
http://www.bea.gov.
7-28
Tax Receipts as a Percentage of GDP in the U.S. and
Selected Countries, 2008
American taxpayers have a relatively low burden in comparison
to taxpayers in other rich nations.
Source: Organization for Economic Cooperation and Development.
7-29
Questions for Thought and Discussion

Is the American income tax regressive or progressive?
•
•
Are payroll taxes regressive or progressive?
Are sales and excise taxes regressive or progressive?

Which tend to be more progressive, federal taxes or state
and local taxes?

What are the arguments for and against raising gasoline
taxes?
7-30
Economic Role of Government
1.
2.
3.
4.
Provision of Public Goods and Services
Redistribution of Income
Stabilization
Economic Regulation
7-31
Provision of Public Goods and Services

Some examples include:
•
•
•
•
•
•
•

Defense of the country
Maintenance of internal order
A nationwide highway network
Provision of a money supply
Public education
Running the criminal justice system
Environmental protection
Private enterprise would not supply these because they
are not profitable.
•
Public goods and services raise our standard of living.
7-32
Redistribution of Income

The government does redistribute hundreds of billions of
dollars every year.
•
•
Social Security redistributes money from those currently working
to those who have retired.
Welfare for the poor

•
Examples are food stamps, Medicaid, disability
payments, and unemployment benefits.
Welfare for the rich

Examples are subsidies to corporate farmers and
tax breaks for defense contractors, oil companies,
and other large corporations.
7-33
Stabilization

Two basic goals of the federal government:
1.
2.

Stable prices with little or no inflation
Low unemployment

An economic rate of growth high enough to keep the
unemployment rate to a minimum.
From the day it took office, the Obama administration
needed to deal with the effects of the worst economic
downturn since the 1930s.
•
•
•
Between fiscal year 2009 and fiscal year 2011 federal
spending leapt from $3.2 trillion to $3.9 trillion.
Taxes were cut, while U.S. Treasury and the Federal Reserve
provided over $2 trillion in loans and loan guarantees to the
nation’s major financial institutions and other large
corporations.
Policies helped end the Great Recession but fueled reaction
against increased economic role of government.
7-34
Economic Regulation

The government provides the economic rules of the
game.
•

Examples: fostering competition, environmental protection, child
labor laws, minimum hourly wage, consumer protection laws and
a court system.
It also provides the social and political context in which
the economy operates.
•
•
The government allow individuals and business firms to operate
with the maximum degree of freedom within this framework.
There is little agreement as to how far economic freedom may be
extended without interfering with society as a whole or the
economic rights of specific individuals or business firms.
7-35
Adam Smith’s Dos and Don’ts

Do:
•
•
•

Protect society from the violence and invasion of other countries.
Establish an exact administration of justice.
Erect and maintain certain public works and institutions where
private enterprise could not profit from doing so.
Don’t do anything else.
7-36
Will Social Security Be There for You?

For decades, the federal government has received
more in Social Security Taxes than it was paying out.
•
•
•

This surplus is deposited in the Social Security trust (trust me)
fund, consisting of U.S. government securities.
However, the surplus is spent by the government each year
to offset its deficits.
The U.S. Treasury places I.O.U.s, (government securities) in
the Social Security trust fund.
In 2010, benefits are expected to exceed tax revenues
because of recession.
•
Because of unemployment, tax receipts lagged and seniors
retired early.
•
Difference is paid out of trust fund by selling government securities.
7-37
Will Social Security Be There for You?
(continued)

Is a Crisis Looming?
•
•
•
•
The baby boomers (born between 1946 and 1964) will start
retiring in this decade.
This means that benefits will continue to exceed revenues.
The securities in the trust fund will continue to have to be sold to
fill in the gap, but will compete in the market with new
government securities issued to pay for deficits.
 Interest rates could skyrocket causing a financial crisis.
Current estimates are that the trust fund will run out around
2037. Does this mean there will be no funds for Social Security
benefits? No!
 Each year, Social Security will collect revenue to pay most of
the benefits.
 The problem is financing the gap once the trust fund runs
out, which can be accomplished by raising payroll taxes
and/or cutting benefits.
7-38
Social Security is the Good News; the
Bad News is Medicare

Medicare is even more seriously under funded than
Social Security.
•
•
•

By 2028 Medicare spending will surpass Social Security
spending.
Remember all those retiring baby boomers?
Health care costs have been rising much faster than
inflation.
Medicare financing is much more complex than
Social Security and harder to fix.
•
•
One goal of health care reform was to reduce costs so
Medicare costs will rise more slowly.
Will it work?
7-39
Questions for Thought and Discussion

How does the present role of government deviate from
the role envisioned by Adam Smith?
•

Would it be possible or desirable to return to a government with a
more limited role?
How can government continue to provide social security
and Medicare?
•
Should the wage limitation on social security taxes be eliminated?
7-40