chapter 14: government revenue and spending “the art of taxation is the art of plucking the goose...

Chapter 14: Chapter 14: Government Government Revenue and Revenue and

SpendingSpending

“The art of taxation is the art of plucking the goose so as to get the largest possible amount of feathers with the least

possible squealing.” - Seventeenth-century French statesman Jean-Baptiste Colbert

““Taxes are what we pay for civilized society”Taxes are what we pay for civilized society” Oliver Wendell Holmes Jr., 1904 Oliver Wendell Holmes Jr., 1904

• 1. What is a tax?• 2. Define revenue.• 3. From what 2

sources may government revenue come?

Taxes, Taxes, TaxesTaxes, Taxes, Taxes

• Definition: System of raising money to finance the government

• Cooking Oil, Foreigners,• Slaves (Ancient Egypt) • Sales, Inheritance, Imports, Exports (Ancient

Rome) • Beards, Beehives, Boots, (Russia, 1702) • Bachelors (England,1695; Missouri, 1820)

Taxes Fund Public Goods and Taxes Fund Public Goods and ServicesServices

National Defense

State and Local Police

Financial Aid

Health Care for Elderly

Public Education

Social Services

• American Revolution caused debt

• Tax was necessary to pay debt

• Article 1, Section 8 of the U.S. Constitution granted Congress power to tax

Taxes in US History

Protective TariffProtective Tariff

4. THINK: What is a tariff?

War of 1812Civil War Income Tax

Conflicting Conflicting Goals of Goals of TaxationTaxation

•Raise revenue•Increase productivity•Economic prosperity

•Be fair

•Influence behavior

1913 Sixteenth Amendment1913 Sixteenth Amendment

• 5. Under what 2 principles are US taxes assigned?

• 6. Identify the “benefits-received principle.”

• 7. Identify the “ability-to-pay principle.”

How to Measure How to Measure Tax FairnessTax Fairness

•Ability to Pay

•Benefits Received

Ability to Pay Ability to Pay PrinciplePrinciple

Those who can afford it

PAY

Benefits Received Benefits Received PrinciplePrinciple

Those who receive the benefits

PAY

Tax Tax ReformReform

Criteria for TaxationCriteria for TaxationRead page 411Read page 411

8. Which criteria establishes fairness by uniformly applying the tax?

Taxes Taxes and and

EquityEquity

•Horizontal Equity: “Equals should be taxed equally.”

•Vertical Equity: “Unequals should be taxed

unequally.”

SimplicitySimplicity9. Which criteria

assesses how easy it is for the taxpayer to understand and how easy for the government to collect?

10. What other two criteria are established for this standard?

EfficiencyEfficiency

• Efficiency differs for the government and the tax payer.

– 11. How is it judged by the government?

– 12. By the tax payer?

– 13. Which tax do we have today which meets both criteria?

The Federal Government The Federal Government Dollar- Where It Comes FromDollar- Where It Comes From

Excise, Customs, Estate, Gift, and

Miscellaneous Taxes7%

Personal Income Taxes

43%Social Security, Medicare,

and Unemployment and other Retirement Taxes

35%

CorporateIncome Taxes

7%Borrowing toCover Deficit 8%

Chief Sources of Revenue

Tax Bases and Structures Tax Bases and Structures

14. Which tax is based on an individual’s income from all sources?

15. What are the 4 primary sources for income?

16. Which tax is based on the value of designated goods or services at the TIME OF THE SALE?

17. Which tax is based on the value of an individual’s or business’s assets?

• What Can Be Taxed?Wealth and

Income

The Federal Government Dollar- The Federal Government Dollar- Where It GoesWhere It Goes

Law Enforcement and General Government

3%

Social Security, Medicare, andother Retirement

38%

National Defense, Veterans, and Foreign Affairs

20%

Social Programs21%

Physical, Human, andCommunity Development

10%

Net Interest onthe Debt

8%

Resource allocation – THINK!18. What happens to the cost of

production?19. What happens to the supply?

Economic Impact of Taxes Economic Impact of Taxes To stimulate the economyTo stimulate the economy

Accounts Receivable TaxBuilding Permit TaxCDL license TaxCigarette TaxCorporate Income TaxDog License TaxExcise TaxesFederal Income TaxFederal Unemployment Tax (FUTA)Fishing License TaxFood License TaxFuel Permit TaxGasoline Tax (currently 44.75 cents per gallon)Gross Receipts TaxHunting License TaxInheritance TaxInventory TaxIRS Interest Charges IRS Penalties (tax on top of tax)Liquor TaxLuxury TaxesMarriage License TaxMedicare Tax

Personal Property TaxProperty TaxReal Estate TaxService Charge T axSocial Security TaxRoad Usage TaxSales TaxRecreational Vehicle TaxSchool TaxState Income TaxState Unemployment Tax (SUTA)Telephone Federal Excise TaxTelephone Federal Universal Service Fee TaxTelephone Federal, State and Local Surcharge TaxesTelephone Minimum Usage Surcharge=2 0TaxTelephone Recurring and Non-recurring Charges TaxTelephone State and Local TaxTelephone Usage Charge TaxUtility TaxesVehicle License Registration TaxVehicle Sales TaxWatercraft Registration TaxWell Permit TaxWorkers Compensation Tax

Currently 47 taxes listed

Tax StructuresTax Structures

• Define the following structures of taxes:

– 20. Proportional Taxes

– 21. Progressive

– 22. Regressive

Proportional TaxProportional TaxTaxes reflect the level of incomeTaxes reflect the level of income

• 23. What else is a proportional tax called?• 24. Why?• 25. What famous college town collects a flat tax?

=

=

Progressive TaxesProgressive Taxes

• 26. Under a progressive tax a high-income person not only pays _____ in the amount of taxes but also pays a __________ on income in taxes.

• 27. To what principle is this type of tax closely linked?

• 28. What is an example of a progressive tax in the US?

Higher Income = Higher Taxes

Personal Income Tax BracketsPersonal Income Tax Brackets

• tax on the income of individuals or families

• applied to wages, salaries, tips, interest, and dividends

• Also called personal income tax

Regressive TaxesRegressive Taxes

• 29. Why is sales tax regressive?

• 30. What other type of taxes is also regressive?

Everyone pays the same fixed amount

Who Pays the Tax?Who Pays the Tax?

• 31. Define incidence of a tax.

• 32. What most often happens to taxes applied to a business?

Circular Flow of Economy Including Taxes

Effect of Elasticity on Effect of Elasticity on TaxesTaxes

• 33. THINK: If a product has an elastic demand, who pays most of the tax?

• 34. WHY?• 35. If the product has an inelastic demand, who pays most of

the tax?• 36. WHY?

Tax on CD Players

Tax Incidence Tax Incidence and Elasticity of Demand / Supplyand Elasticity of Demand / Supply

• 37. Perfectly Demand: Buyer Pays Entire Tax

• 38. Perfectly Demand: Seller Pays Entire Tax

• 39. Perfectly Supply: Seller Pays Entire Tax

• 40. Perfectly Supply: Buyer Pays Entire Tax

INELASTIC

ELASTIC

INELASTIC

ELASTIC

Impact of Taxes on the Impact of Taxes on the EconomyEconomy

• 41. What happens to the cost of production if a tax is placed on a good or service?

• 42. Where will this shift the supply curve?

• 43. Why will the producer NOT pass the tax for luxury yachts on to the consumer?

• 44. THINK – What will be the short term and long term effect of this tax on a luxury good?

Increase Productivity and Increase Productivity and GrowthGrowth

• Taxes change incentives to:

– Save– Invest– Work– Spend

• 45. When taxes on interest and dividends are high what happens?

• 46. How will this affect capital investment as well?

• 47. How do economists believe high taxes affect labor?

Effects of Tax

on Labor Income

Other Effects of TaxationOther Effects of Taxation

48. THINK: How is an underground economy affected by high taxes?

49. THINK: How will this affect the collection of taxes by the government?

50. THINK: What is a huge example of this today?

Lowering taxes on labor will lead to more take-home pay, and also means that employers can

set wages lower because workers will be satisfied by the higher percentage of money they take

home after taxes - Used by Bush against Reagan

Behavior AdjustmentBehavior Adjustment

• 51. What is a tax incentive?• 52. What types of tax

incentives may be used by the government?

• 53. What is the largest tax credit given by the government today?

• 54. What are sin taxes? • 55. What are some examples

today of sin taxes?• 56. How does the elasticity

for an item which carries a sin tax change as the tax increases?

Tax Incidence and the

Elasticities of Demand

and Supply: Elastic Demand

Tax Incidence and the

Elasticities of Demand

and Supply: Inelastic Demand

Congress has Congress has set a goal set a goal

that 80% of that 80% of all tax all tax

returns be returns be filed filed

electronically electronically by the year by the year

2007.2007.

• 57. How much revenue does the federal government take in from taxes each year?

Understanding the IRS

Each person is responsible for filing a tax return.

•Keep necessary records•Report income accurately •Correctly calculate tax liability• File returns on time•SAVE

•Paycheck stubs•Bank statements•Completed tax returns and forms•Warranty information•Receipts•Credit card statements

•Three methods for tax preparation?•Electronically•Tax Preparation Software•Manually

Voluntary ComplianceVoluntary ComplianceRequires Record KeepingRequires Record Keeping

Withholding on Form W-4Withholding on Form W-4

•58. Why would it be difficult for the government to only collect taxes one time during the year?

•59. What is the type of tax taken from a worker’s paycheck called?

Form W-2 Form W-2

• 60. The federal income tax is a ? Tax.

• 61. This means people with ? Incomes not only pay ? In total taxes, but also pay a higher ? Of their income in taxes.

• 62. On what is the amount owed based?

•Shows how much employees earn•Copy must be attached to tax return

Factors Affecting Tax Factors Affecting Tax LiabilityLiability

• 63. How can taxpayers reduce their tax burden?

• Deductions: Expenses that can be deducted before determining taxable income

– 64. How does family size make a difference in deductions?

– 65. What are some other examples of items which may be deducted?

Tax BreaksTax Breaks

Deductions:Reduce income subject to tax

Tax Exemptions:Part of income that isn’t taxed

Tax Credits:Dollar for dollar reduction in tax

66. What is a tax return?

67. What is a requirement for a tax return?

68. Why might you have to pay additional taxes?

Tax Avoidance Tax Avoidance versus versus

Tax EvasionTax Evasion•Tax Evasion: Failure to pay legally due taxes

•Tax Avoidance: Legal means of decreasing your tax bill

IndexingIndexing

• 69. What is a tax bracket?• 70. What is the purpose of indexing?

71. What does FICA stand for?71. What does FICA stand for?

Federal Insurance Contributions ActFederal Insurance Contributions Act– Known as ‘Social Security’ or Payroll tax– 2009 FICA Tax and Social Security Limits. – FICA Tax Rate = 7.65%; – Social Security Limit = $106800; – Maximum Social Security Contribution = $6621.60 ...

Medicare and UnemploymentMedicare and Unemployment

72. What group benefits from Medicare

73. What is different about the collection of social security and Medicare?

74. How are unemployment taxes funded?

75. THINK: Why is this an example of federalism?

76. Who pays the majority of unemployment tax?

77. THINK: What is the effect of unemployment tax on businesses?

Tax Lesson 101 Tax Lesson 101

• Suppose that every day, ten men go out for dinner. The bill for all ten comes to $100.

If they paid their bill the way we pay our taxes, it would go something like this: The first four men (the poorest) would pay nothing. The fifth would pay $1. The sixth would pay $3. The seventh $7. The eighth $12. The ninth $18. The tenth man (the richest) would pay $59.

So, that's what they decided to do.

What Happens When the What Happens When the Owner Reduces the Cost?Owner Reduces the Cost?

• The ten men ate dinner in the restaurant every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve.

"Since you are all such good customers," he said, "I'm going to reduce the cost of your daily meal by $20."

So, now dinner for the ten only cost $80. The group still wanted to pay their bill the way we pay our taxes.

So, the first four men were unaffected. They would still eat for free. But what about the other six, the paying customers? How could they divvy up the $20 windfall so that everyone would get his 'fair share'?

The six men realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being 'PAID' to eat their meal.

To Reduce Each Man’s BillTo Reduce Each Man’s Bill• So, the restaurant owner suggested that it would be fair to reduce each man's

bill by roughly the same amount, and he proceeded to work out the amounts each should pay.

And so: The fifth man, like the first four, now paid nothing (100%savings). The sixth now paid $2 instead of $3 (33% savings). The seventh now paid $5 instead of $7 (28% savings). The eighth now paid $9 instead of $12 (25% savings). The ninth now paid $14 instead of $18 (22% savings). The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to eat for free. But once outside the restaurant, the men began to compare their savings.

"I only got a dollar out of the $20," declared the sixth man. He pointed to the tenth man "but he got $10!"

"Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got ten times more than me!"

"That's true!!" shouted the seventh man. "Why should he get $10 back when I got only $2? The wealthy get all the breaks!"

And that, boys and girls, journalists and college professors, And that, boys and girls, journalists and college professors, is how our tax system works.is how our tax system works.

• "Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!" The nine men surrounded the tenth and beat him up.

The next night the tenth man didn't show up for dinner, so the nine sat down and ate without him. But when it came time to pay the bill, they discovered something important. They didn't have enough money between all of them for even half of the bill!

The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up at the table anymore. There are lots of good restaurants in Europe and the Caribbean.

Direct TaxDirect TaxBurden falls directly on the person Burden falls directly on the person

or thing being taxedor thing being taxed

• Cannot be shifted to another person or thing.– Includes personal income tax or – property tax on a residence

Indirect TaxesIndirect Taxes tax imposed on one person or thing but whose tax imposed on one person or thing but whose

burden is borne indirectly by anotherburden is borne indirectly by anotherIndirect Tax:

•Can be recovered by charging higher prices

or paying lower wages

•Sales tax, business

property tax, and payroll tax can be shifted

Corporate Income and Other TaxesCorporate Income and Other Taxes

• A tax on the profits, or net income of corporations.

78. What is an Estate tax?– known as ‘death tax’

• What was supposed to happen to the estate tax in 2010?

• Why will this not happen now?

79. What is taxed by the Gift tax?

– on gifts received in excess of set sum

What is an Excise TaxWhat is an Excise Tax

A user tax that generates revenue to build and maintain roadways80. Why is gasoline a good source for an excise tax? 81. How can an excise tax be used as a sin tax?

Customs Duty and User FeesCustoms Duty and User Fees

82. What is a Customs duty?

83. What is a user fee?

84. What is an example of a user fee?

Property TaxesProperty Taxes•Levied on property, especially real estate

•Can also be levied on boats, RVs,

business inventories

•Fund schools, local services, welfare programs

Transaction Transaction Taxes Taxes

(Consumptio(Consumption Taxes)n Taxes)

•Levied on economic transactions

•Set on percentages or physical quantities

•Support state and local services85. What is an example on the state level of a transaction

tax?

The U.S. Constitution The U.S. Constitution Divides Government Divides Government

PowersPowersFederal Responsibilities

State Responsibilities

Local Responsibilities

Tax Freedom DayTax Freedom Day

How Taxes EvolveHow Taxes Evolve

House Ways and Means Committee

Full House

Senate Finance Committee

Full Senate

Joint Conference Committee

Senate/House Compromise bill

President vetoes bill

Tax law enacted

President signs bill

Veto override fails Veto override passes

Taxation Around the

World

History of Taxation in the United States

A recession is when your neighbor loses his job. A depression is when you lose your job.

Trouble Brewing with Tax ReformTrouble Brewing with Tax Reform

• Value-added tax A percentage tax on the value added to goods or services at each stage of production and distribution. As with general sales taxes, consumers bear the final burden of value-added taxes

““The income tax The income tax law is a lot of law is a lot of

bunk. The bunk. The government can’t government can’t collect legal taxes collect legal taxes

from illegal from illegal money.”money.” Al Capone

Failure to pay legally owed taxes can result in fines or imprisonment fortax fraud or tax evasion.

Al Capone, a man remembered as one of the most notorious criminals of the twentieth century, was imprisoned for tax evasion in June, 1930.

Spiro Agnew, our thirty–ninth vice president (1969–1973), resigned from office after being fined for tax evasion.

Be smart: Pay all taxes owed to the government

Federal Government Federal Government SpendingSpending

86. Define mandatory spending

87. Define discretionary spending

88. Define entitlements

89. What are three important types of entitlements?

Federal ExpendituresFederal Expenditures

90. What is discretionary spending?

91. What are the 5 main categories of this spending?

92. Which part of this budget is the largest?

Federal Budget Discretionary Federal Budget Discretionary 20092009

• $70.4 billion - United States Department of Health and Human Services

• $45.4 billion - United States Department of Education

• $44.8 billion - United States Department of Veterans Affairs

• $38.5 billion - United States Department of Housing and Urban Development

• $38.3 billion - State and Other International Programs

• $37.6 billion - United States Department of Homeland Security

• $25.0 billion - United States Department of Energy

• $20.8 billion - United States Department of Agriculture

• $20.3 billion - United States Department of Justice

• $17.6 billion - National Aeronautics and Space Administration

• $12.5 billion - United States Department of the Treasury

• $11.5 billion - United States Department of Transportation

• $10.6 billion - United States Department of the Interior

• $10.5 billion - United States Department of Labor

• $8.4 billion - Social Security Administration

• $7.1 billion - United States Environmental Protection Agency

• $6.9 billion - National Science Foundation • $6.3 billion - Judicial branch (United States

federal courts) • $4.7 billion - Legislative branch (United

States Congress) • $4.7 billion - United States Army Corps of

Engineers • $0.4 billion - Executive Office of the

President • $0.7 billion - Small Business

Administration • $7.2 billion - Other agencies • $39.0 billion(2008*) - Other Off-budget

Discretionary Spending • The financial cost of the Iraq War and

the War in Afghanistan are not part of the defense budget; they are appropriations.

What does the Constitution say about Taxes?What does the Constitution say about Taxes?

• U.S. Constitution, Article 1, Section 8:

• “The Congress shall have power to lay and collect taxes, duties, imposts and excises, to pay the debts and provide for the common defense and general welfare of the United States …

Establishing the BudgetEstablishing the Budget

• The president presents his budget proposal to Congress in early February.

• Congress is free to adopt or reject any of the president's recommendations.

93. What is the fiscal year?94. Who prepares the

President’s budget?

What Happens in Congress?What Happens in Congress?

• Congress adopts a budget resolution establishing targets • Thirteen appropriations subcommittees divide the funds 95. What are appropriations?96. What must occur if Congress does not pass a budget by the

start of a new fiscal year?

Impact on our EconomyImpact on our Economy

97. In what 3 ways does federal spending impact our economy?

Federal Debt as Percent of Federal Debt as Percent of GDPGDP

98. Explain resource allocation.

Myth: Today’s Debt is at Historic Levels.Myth: Today’s Debt is at Historic Levels.Fact: Today’s Debt Burden is Not that Large Fact: Today’s Debt Burden is Not that Large

in Historical Context.in Historical Context.

US Gross Federal DebtUS Gross Federal Debt

• This chart reflects gross federal debt from 1940-2007 in unadjusted dollars.

• Note that for half of this period, the debt remained fairly stable.

• It is not until 1981, with the tax cuts and military spending that marked the Reagan Administration, that the debt began its current trajectory.

How big is the Debt?How big is the Debt?

The National Debt is $19 Trillion!

State and Local Taxes and State and Local Taxes and

SpendingSpending • When the federal

government shares it is called Intergovernmental Revenues – funds collected by federal government and distributed to states and local

99. What is the primary tax for most states?

100. What goods are often exempt from these taxes?