© 2005 thomson c hapter 30 financing government: taxes and debt

© 2005 Thomson

CChapter 30hapter 30

Financing Financing Government: Taxes Government: Taxes

and Debtand Debt

2

© 2005 Thomson

Gottheil - Principles of Economics, 4e

Economic PrinciplesEconomic Principles

Commandeering resources

Commandeering money (taxes)

Regressive, proportional, and progressive tax structures

3

© 2005 Thomson


Economic PrinciplesEconomic Principles

Social Security taxes

Government securities and public debt

Internally and externally financing the debt

4

© 2005 Thomson


EXHIBIT 1 PRODUCTION POSSIBILITIES CURVE

5

© 2005 Thomson


Exhibit 1: Production Exhibit 1: Production Possibilities CurvePossibilities 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.

6

© 2005 Thomson


Commandeering Commandeering ResourcesResources

What is the most direct method available for a government to acquire resources?• The most direct method is to commandeer resources.

7

© 2005 Thomson



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.

8

© 2005 Thomson



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.

9

© 2005 Thomson


The Tax SystemThe 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.

10

© 2005 Thomson


There’s More Than There’s More Than One Way to Levy One Way to Levy

TaxesTaxesPoll tax

• A tax of a specific absolute sum levied on every person or every household.

11

© 2005 Thomson



TaxesTaxesRegressive 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.

12

© 2005 Thomson



TaxesTaxes1. What is an example of a regressive income tax?• One example is a poll tax.

13

© 2005 Thomson



TaxesTaxes1. 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.

14

© 2005 Thomson



TaxesTaxesProportional income tax

• A tax that is a fixed percentage of income, regardless of the level of income.

15

© 2005 Thomson



TaxesTaxes2. What is an example of a proportionate income tax?• A flat-rate tax on personal income

16

© 2005 Thomson



TaxesTaxesProgressive 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.

17

© 2005 Thomson



TaxesTaxes3. What is an example of a progressive income tax?• The current system of federal income taxation is progressive.

18

© 2005 Thomson



TaxesTaxesCorporate income tax

• A tax levied on a corporation’s income before dividends are distributed to stockholders.

19

© 2005 Thomson


Are We Really Paying Are We Really Paying High Taxes?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

20

© 2005 Thomson



•Tax revenues in the U.S. were 34.3 percent of GDP.


21

© 2005 Thomson


• 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.


22

© 2005 Thomson



TaxesTaxesProperty tax

• A tax levied on the value of physical assets such as land, or financial assets such as stocks and bonds.

23

© 2005 Thomson



TaxesTaxesUnit tax

• A fixed tax in the form of cents or dollars per unit, levied on a good or service.

24

© 2005 Thomson



TaxesTaxesSales tax

• A tax levied in the form of a specific percentage of the value of the good or service.

25

© 2005 Thomson



TaxesTaxesCustoms duty

• A sales tax applied to a foreign good or service.

26

© 2005 Thomson



TaxesTaxesExcise tax

• Any tax levied on a good or service, such as a unit tax, a sales tax, or a customs duty.

27

© 2005 Thomson



TaxesTaxes4. Complete the following sentence:

All excise taxes are ______.

28

© 2005 Thomson



TaxesTaxes4. Complete the following sentence:

All excise taxes are regressive.

29

© 2005 Thomson



TaxesTaxes5. 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.

30

© 2005 Thomson



TaxesTaxes5. 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.

31

© 2005 Thomson



TaxesTaxes6. 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.

32

© 2005 Thomson


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.

33

© 2005 Thomson


Exhibit 2: 2003 Tax Rate Exhibit 2: 2003 Tax Rate Schedule for Married Schedule for Married Persons Filing JointlyPersons 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.

34

© 2005 Thomson



• On the next $21,400 they pay 15%, which equals $3,200.

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?

35

© 2005 Thomson



• On the next $40,400 they pay 25%, which equals $10,100.


10100

36

© 2005 Thomson



• On the final $31,100 they pay 28%, which equals $10,296.


10100

37

© 2005 Thomson



• Thus the married couple pays a total of $(700 + $3210 + $10,100 + 8,736) = $22,746.


38

© 2005 Thomson


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).

39

© 2005 Thomson


Exhibit 3: Federal, State, and Exhibit 3: Federal, State, and Local Government Revenues: Local Government Revenues:

2002 ($ billions)2002 ($ billions)

Complete the sentence:

______ taxes are the largest single source of combined government tax revenues.

40

© 2005 Thomson


Exhibit 3: Federal, State, and Exhibit 3: Federal, State, and Local Government Revenues: Local Government Revenues:

2002 ($ billions)2002 ($ billions)

Complete the sentence:

Income taxes are the largest single source of combined government tax revenues.

41

© 2005 Thomson


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),

42

© 2005 Thomson


Exhibit 4: The Federal Exhibit 4: The Federal Government’s Surpluses Government’s Surpluses

and Deficits: 1970–2002 ($ and Deficits: 1970–2002 ($ billions)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.

43

© 2005 Thomson


Financing Financing Government Government

Spending Through Spending Through DebtDebtPublic debt

• The total value of government securities—Treasury bills, notes, and bonds—held by individuals, businesses, other government agencies, and the Federal Reserve.

44

© 2005 Thomson


EXHIBIT 5 OWNERSHIP OF THE U.S. PUBLIC DEBT: 2002 (PERCENTAGE OF TOTAL)

*Savings and loan associations, nonprofit institutions, credit unions, mutual savings banks, corporate pension trust funds, certain U.S. Treasury deposit accounts, and federally sponsored agencies.Source: Federal Reserve Bulletin (Washington, D.C., October 2003).

45

© 2005 Thomson


Exhibit 5: Ownership of the Exhibit 5: Ownership of the U.S. Public Debt: 2002 U.S. Public Debt: 2002 (percentage of total)(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.

46

© 2005 Thomson


Exhibit 5: Ownership of the Exhibit 5: Ownership of the U.S. Public Debt: 2000 U.S. Public Debt: 2000 (percentage of total)(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.

47

© 2005 Thomson


Financing Financing Government Sending Government Sending

Through DebtThrough DebtWhich 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

48

© 2005 Thomson


Tracking Government Tracking Government DebtDebt

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.

49

© 2005 Thomson


EXHIBIT 6A THE FEDERAL DEBT

Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).

50

© 2005 Thomson


EXHIBIT 6B THE FEDERAL DEBT

Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).

51

© 2005 Thomson


Exhibit 6: The Federal Exhibit 6: The Federal DebtDebt

1. During what time period did the gross federal debt grow most rapidly?• During the period between approximately 1980 and 2000.

52

© 2005 Thomson



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.

53

© 2005 Thomson



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.

54

© 2005 Thomson



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.

55

© 2005 Thomson



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.

56

© 2005 Thomson



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.

57

© 2005 Thomson


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.

58

© 2005 Thomson


Hatred of Tax Hatred of Tax Collection is the Way Collection is the Way

of the Worldof the WorldIn which of the following countries do tax collectors wear commando uniforms and carry weapons:a. Sweden

b. France

c. Russia

59

© 2005 Thomson


Hatred of Tax Hatred of Tax Collection is the Way Collection is the Way

of the Worldof the WorldIn which of the following countries do tax collectors wear commando uniforms and carry weapons:a. Sweden

b. France

c. Russia

60

© 2005 Thomson


Does Debt Endanger Does Debt Endanger Future Generations?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.

61

© 2005 Thomson



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.

62

© 2005 Thomson



In addition, increased government debt purchased by the Fed will increase the money supply, which can be inflationary.

63

© 2005 Thomson



Another problem with increased government debt is that it tends to crowd out private investment, which slows the rate of economic growth.

65

© 2005 Thomson



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.

66

© 2005 Thomson


Are Deficits and Debt Are Deficits and Debt Inevitable?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.

67

© 2005 Thomson



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.

68

© 2005 Thomson



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.

69

© 2005 Thomson



The combination of the Clinton presidency, the Republican Congress, and sustained economic growth eliminated budget deficits by the late-1990s.

70

© 2005 Thomson



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.

© 2005 thomson c hapter 30 financing government: taxes and debt

Documents

gottheil principles

taxes regressive income

e commandeering resources

tax system

consumption tax

proportionate income

taxes proportional income

e theres