DeficitsDeficits, SurplusesSurpluses,, and the National DebtNational Debt

• Marriage License Tax

• Medicare Tax• Personal Property

Tax• Property Tax

• Real Estate Tax• Service Charge Tax• Social Security Tax

• Road Usage Tax• Sales Tax

• Recreational Vehicle Tax

• School Tax• State Income Tax

• State Unemployment Tax

(SUTA)• Telephone Federal

Excise Tax• Telephone Federal

Universal Service Fee Tax

• Telephone Federal, State and Local

Surcharge Taxes• Telephone

Minimum Usage Surcharge Tax

• Telephone Recurring and Non-recurring Charges Tax

• Accounts Receivable Tax

• Building Permit Tax

• CDL license Tax• Cigarette Tax

• Corporate Income Tax

• Dog License Tax• Excise Taxes

• Federal Income Tax

• Federal Unemployment Tax

(FUTA)• Fishing License

Tax• Food License Tax• Fuel Permit Tax• Gasoline Tax (42

cents per gallon)• Hunting License

Tax• Inheritance Tax• Gross Receipts

Tax• Inventory Tax• IRS Interest

Charges IRS Penalties (tax on

top of tax)• Liquor Tax

• Luxury Taxes• Workers Comp Tax

• Tax his car,• Tax his gas,

• Find other ways• To tax his ass• Tax all he has

• Then let him know• That you won't be done

• Till he has no dough.• When he screams and hollers,

• Then tax him some more,• Tax him till

• He's good and sore.• Then tax his coffin ,

• Tax his grave,• Tax the sod in

• Which he's laid.• Put these words• upon his tomb,

• " Taxes drove me to my doom..."• When he's gone,

• Do not relax,• Its time to apply

• The inheritance tax.• Utility Taxes

• Vehicle LicenseRegistration tax

Vehicle Sales Tax Watercraft

Registration TaxWell Permit Tax

Tax his land, Tax his bed, Tax the table At which he's fed. Tax his tractor, Tax his mule, Teach him taxes Are the rule. Tax his cow, Tax his goat, Tax his pants, Tax his coat. Tax his ties, Tax his shirt, Tax his work, Tax his dirt. Tax his tobacco, Tax his drink, Tax him if he Tries to think. Tax his cigars, Tax his beers, If he cries, then Tax his tears. Telephone State &

Local Tax Telephone Usage

Charge Tax Utility Taxes

Chapter Chapter ObjectivesObjectives:1. Explain the difference between the difference between the budget deficitbudget deficit and and public debtpublic debt.2. Explain each of the three budget philosophiesthree budget philosophies. A. Annually balanced budgetAnnually balanced budget B. Cyclically balanced budgetCyclically balanced budget, and C. Functional FinanceFunctional Finance3. Identify the principal principal causes of the public debtcauses of the public debt. A. Wartime financing B. Fighting recessions C. Tax cuts D. Lack of political will4. Describe the annual interest chargesannual interest charges on the debton the debt, who holds the debtwho holds the debt and the impact of accounting and inflation on the debt.5. State the absolute sizeabsolute size of the debtof the debt and the relative sizerelative size as a % of GDPas a % of GDP.6. Explain why the debt can also be considereddebt can also be considered public creditpublic credit.7. Identify and explain two widely held myths about the public debttwo widely held myths about the public debt. A. Going bankruptGoing bankrupt B. Burden on our grandchildrenBurden on our grandchildren8. Explain the effect of the debt on income distributioneffect of the debt on income distribution and Igand Ig.9. Explain how the debtdebt [& higher interest rateshigher interest rates] mightmight decrease net exportsdecrease net exports.10. Explain 3 proposed remedies to reduce or to eliminate budget deficits3 proposed remedies to reduce or to eliminate budget deficits.

And the concept of And the concept of “crowding-in”“crowding-in”

10%10%

8%

6%6%

4%

2%

IIGG Rea

l in

tere

st

rate

DDII

Investment (billions of dollars)

[Incr G incr I.R. [Incr G incr I.R. Decr IgDecr Ig]]

5 10 155 10 15 20 2520 25

CrowdingCrowdingOut EffectOut Effect

ASASADAD11 AD2AD2

44%%

22%%

YYRR

GG

FriedmanFriedmanJust follow theJust follow the

““monetary rule.”monetary rule.”

YY**

DD11DD22 ss

66%%

1010%%

Quantity of LFQuantity of LFFF11 FF22

PLPL

Rea

l I.R

.R

eal I

.R.Loanable FundsLoanable Funds

MarketMarket

1515

In this case, it would be 100% “crowding out”.In this case, it would be 100% “crowding out”.

G can finance a deficit by:G can finance a deficit by:1. 1. BorrowingBorrowing - this - this raises interest rates raises interest rates in thethe LFM and LFM and “crowds out”“crowds out” investment. investment.

2. 2. Money CreationMoney Creation - no “crowding out”- no “crowding out” so is so is more expansionarymore expansionary than borrowing. than borrowing.

0

DDII11

Investment (billions of dollars)

Re

al i

nte

res

t ra

te (

%)

1616

1414

1212

1010

88

66

44

22

005 10 1515 20 2525 30 35 40

DDII22ASASADAD11

ADAD22

YYRR YY**

GG

But … if the economy is operating well below its potentialeconomy is operating well below its potential, increased government spendingincreased government spending could result in more jobs, more positive profit expectations, and a “crowding in” of Igcould result in more jobs, more positive profit expectations, and a “crowding in” of Ig.

How “Crowding In” Might How “Crowding In” Might WorkWork“Crowding In” – potential for G spending to stimulate

private investment in an otherwise sluggish economy.“Crowding OutCrowding Out” represents argument for passive fiscal policypassive fiscal policy.“Crowding InCrowding In” would be an argument for active fiscal policy. If the economy is operating well below its potentialbelow its potential, the additionalfiscal stimulus provided by deficit spending could encourage firms to invest more. A G deficit could stimulate a weak economy, increasingAD & putting a “sunny face on business expectations.” As businessexpectations grow more favorable, firms could become more willingto invest. [thus, “crowding in” of investment] If you have ever approached a crowded restaurantcrowded restaurant, you may not have wanted to put up with the hassle of a long waitlong wait and were thus““crowded out.”crowded out.” Similarly, large G deficits may drive up interest rateslarge G deficits may drive up interest ratesand crowd out some investment.and crowd out some investment.

On the other hand, did you ever pass up a restaurant because the placeseemed dead-it had few customers. Perhaps you wondered why so few people chose to eat there. With just a few more customers, you might havebeen willing to “crowd in.” Businesses may be reluctant to invest in a lifelesseconomy. Economic stimulus could encourage them to “crowd in.”

As Yoga Berra would say, “No one “No one goes there any more. It’s too crowded.”goes there any more. It’s too crowded.” Yoga also said, “If you come to a fork Yoga also said, “If you come to a fork in the road, take it.”in the road, take it.”

1.Annually Balanced Budget2.Cyclically Balanced Budget3.Functional Finance

[A. Annually Balanced; B. Cyclically Balanced; C. Functional Finance][A. Annually Balanced; B. Cyclically Balanced; C. Functional Finance]

EconomyEconomy

Annually Balanced BudgetAnnually Balanced Budget – each time the earth orbits the sunearth orbits the sun weshould balance the budgetbalance the budget.

This would put the G in an economic straitjacketeconomic straitjacket as we couldn’t fight

recessions with deficit spending. This would be like pouring water on pouring water on a drowning mana drowning man. . We used to worship at the alter of a balancedworship at the alter of a balancedbudgetbudget prior to the Great Depression. 49 states require this.

Balancing the budget during a recession would not be counter-cyclicalnot be counter-cyclical, but pro-cyclicalpro-cyclical. Increasing taxesIncreasing taxes during a recession would worsen theworsen the

recessionrecession. Running aRunning a surplus during boomsurplus during boom timestimes and giving the giving the money back would be inflationarymoney back would be inflationary.

““Earth Orbits Sun”Earth Orbits Sun” ““G”G”

ADAD11

BalancingBalancing the the BudgetBudget – during – during RecessionRecession[[Increase TIncrease T or or Decrease GDecrease G - - ProcyclicalProcyclical

ASAS

PLPL11

PLPL22

YYRR YY**

PLPL33

YYRR

So, the fiscal actionsto balance the budgetdecreasesdecreases, rather than

increasesincreases ADAD, and isprocyclicalprocyclical, not countercounter.

ADAD33

ADAD22

CutCut

ADAD11

Balancing Balancing the the Budget - Budget - during during InflationInflation[Decrease T or Increase G - [Decrease T or Increase G - ProcyclicalProcyclical]]

ASAS

PL1

PL3

YY** YYIIYYII

PLPL22So, the fiscal actionsto balance the budget

increaseincrease, ratherthan decrease decrease ADAD,& is also procyclicalprocyclical,rather than countecounter.

ADAD33ADAD22

RecessionRecession““Tax cut”Tax cut”

InflationInflation““Raise taxes”Raise taxes”

Cyclically Balanced BudgetCyclically Balanced Budget – run deficits during recessionsdeficits during recessions &

surpluses during expansionssurpluses during expansions so the budget is balanced not each yearbut over the course of the business cyclecourse of the business cycle. Economic wisdom tells us we should have deficits in lean yearsdeficits in lean years and surpluses in fat yearssurpluses in fat years. There is nothing “sacred about 12 months asnothing “sacred about 12 months as an accounting period.”an accounting period.”The government could conduct counter-cyclical fiscal policycounter-cyclical fiscal policy and balance balance its budget over a period of yearsits budget over a period of years. The basic problem of this philosophy isthat fluctuations are not usually symmetrical enough to ensure that thesurplus will offset the deficit.

““DeficitDeficit Spending”Spending”““Balanced”Balanced”

Tax Tax CutsCuts

RaiseRaiseTaxesTaxes

Functional FinanceFunctional Finance – balance the economybalance the economy not the budget.The annual or cyclically balanced budget is of secondary importanceannual or cyclically balanced budget is of secondary importance. Theimportant thing is to provideprovide for non-inflationary for non-inflationary, , FEFE & ensure the economyproduces its potential GDP. If there are chronic deficitsdeficits or surplusessurpluses, so be it.Deficits are minor problemsDeficits are minor problems, compared to inflationinflation or recessionsrecessions.

U.S.U.S.EconomyEconomy

““Balance the economy, not the budget.”Balance the economy, not the budget.”

The The “Debt”“Debt” and theand the “Deficit”“Deficit”FlowFlow

($162 bil.) StockStock($9.4 trillion)

Reasons for DebtReasons for Debt1. Lack of political will2. Tax cuts3. Recessions (transfers)4. Wartime financing

[ADD] Attention [ADD] Attention Deficit Disorder Deficit Disorder CCongressmen haveongressmen have trouble focusing trouble focusing attention attention on theon the deficit. deficit.

$9.49.4

$9.4 $9.4 tril.tril.

Per CapitaPer Capita

The Debt is increasing by $1 million per minute. The Debt is increasing by $1 million per minute.

$33,000$33,000

9,

3,3

11 44 0,0,

44

$1.58 billion per day is being added to the debt.$1.58 billion per day is being added to the debt.

Yea! We don’t have Yea! We don’t have to pay any federal to pay any federal income or SS taxes.income or SS taxes.

Three major sourcesThree major sourcesof federal taxes(90%)of federal taxes(90%) a. Individual incomea. Individual income taxes taxes b. Social Insuranceb. Social Insurance c. Corporate incomec. Corporate income taxestaxes45%45%

$1,096 $1,096

37%37%$884 bil.$884 bil. 11%11%

$261 B$261 B

7%7%$$179 179 BB

DeficitDeficit$248 bil.$248 bil.

We are paying about We are paying about $1 trillion in taxes.$1 trillion in taxes.

Agriculture 90.9 Interest [$243Interest [$243]]Commerce 6.7Defense 527.6Education, job train. 62.6Energy, Environment 21.6Health/Human SVC 699.0Homeland Security 34.6Housing/Urban Dev. 36.2Interior 10.1Justice, Law enforce 23.3Labor 50.4NASA 17.3SEC & Exchange Com. 8.5 Corp Engineers 4.8State 37.4 Social Security 655.5Transportation 67.3 Legislative Branch 4.8Treasury 525.5 Judiciary 6.7Veteran’s Affairs 84.4 Other agencies 148.7

2008 Federal Budget Proposal-$2.9 2008 Federal Budget Proposal-$2.9 Tril.Tril.

$67.3$67.3

Federal Spending in 2007, by FunctionFederal Spending in 2007, by Function

DEFICITSDEFICITS,, SURPLUSESSURPLUSES,, ANDAND DEBTDEBTDefinitionsDefinitions::Budget Deficit [G >G > TT]

Budget Surplus [T >T > GG]

National or Public Debt

U.S. Securities

1. Progressive1. Progressive2. Proportional2. Proportional3. Regressive3. Regressive

Single - noSingle - no tax on 1tax on 1stst

$7,825$7,825

35%35%

33%33%

28%28%

25%25%

15%15%

10%10%

$$7,8257,825 $164,550$164,550 $$357,700357,700

Standard DeductionStandard Deduction[$5,350-dependent] [$5,350-dependent]

00 $78,850$78,850 $$357,700+357,700+$$32,55032,550

10%10% 15%15% 25%25% 28%28% 33%33% 35%35%

Marg

inal

Marg

inal Tax R

ate

s T

ax R

ate

sFlat Tax on Income: Flat Tax on Income: same % of income, different amounts, so same % of income, different amounts, so ProportionalProportionalFlat Tax on Products: Flat Tax on Products: same amount, different % of income, so same amount, different % of income, so RegressiveRegressive

I only have I only have to pay the to pay the FICA tax.FICA tax.

Progressive

Progressive – takes a la

rger % fro

m high income groups

– takes a la

rger % fro

m high income groups

[$15,650-married filing jointly][$15,650-married filing jointly][$11,200-HH][$11,200-HH][7,825-single][7,825-single]

Our Progressive Tax System Is Like A LLaayyeerreedd CCaakkee

35% over $357,700

No tax on 1st $7,825

10% up to $16,050

15% up to $29,700

25% up to $78,850

28% up to $164,55033% up to 357,700

Regressive

Regressive– – takes a larger % from low income groups

takes a larger % from low income groups

ProportionalProportional && Regressive Regressive TaxesTaxes

$100,000$100,000

ProportionalProportional – – takes same 20% [takes same 20% [not amountnot amount] from all income groups] from all income groups2020%%

$30,000$30,000 $40,000$40,000 $50,000$50,000

2020%%

3030%%

1010%%

$30,000$30,000 $40,000$40,000 $50,000$50,000

Take that, you Take that, you “low incomer.”“low incomer.”

PayPay $20,000 $20,000PayPay $10,000 $10,000[So, [So, not same amountnot same amount but same %, 20%] but same %, 20%]

I’m a “lowI’m a “lowincomer.”incomer.”

Example: Example: MedicareMedicare – 1.45% on all income earned. – 1.45% on all income earned.

Example: Example: Sales TaxSales Tax

Toll RoadToll Road($1 per day) $10,000 $50,000$10,000 $50,000

$200$200 $200$200 2% .4%2% .4%

Flat TaxFlat Tax on on IncomeIncome: s: sameame % of % of income, dincome, differentifferent amounts,amounts, so so proportionalproportional..Flat TaxFlat Tax on on ProductProduct: s: sameame amount, different % amount, different % of of incomeincome, so, so regressiveregressive..

State State 6.25%6.25% Excise Tax on Excise Tax on TwoTwo Identical $ Identical $20,00020,000 Autos Autos BO MO

Flat Tax on CigarettesFlat Tax on Cigarettes [ExciseExcise][$1.41 cents pack][1 pack day] [1 pack day]

$10,000 $100,000 $515 $515 5% .5%5% .5%

AddictedAddicted

$10,000 $100,000$10,000 $100,000 $1,250$1,250 $1,250$1,250 12.5% 1.25%12.5% 1.25%

$100 Spent On The Lottery$100 Spent On The Lottery$20,000 $100,000

[$100 Lottery] [$100 Lottery]

5%5% .1%.1%“The lottery tax is a voluntary voluntary

regressiveregressive tax on moronstax on morons.”What about the .20 a gallon gasoline tax?So – all of these taxes were regressiveregressive.

Property Tax of 2.5% Property Tax of 2.5% on on $100,000 $100,000 HousesHouses

$25,000 $50,000$25,000 $50,000 [100,000 house] [$100,000 house][100,000 house] [$100,000 house]

$2,500$2,500 $2,500$2,500 10% 5%10% 5%

Flat Tax on Income: Flat Tax on Income: same % of income, different amounts, sosame % of income, different amounts, so ProportionalProportionalFlat Tax on Products: Flat Tax on Products: same amount, different % of income, sosame amount, different % of income, so RegressiveRegressive

I played I played the lottery.”the lottery.”

TAX RATE TAX RATEState (Cents per pack) Rank State (Cents per pack) RankAlabama(1) 16.5 47 Nebraska 64 24Alaska 200 4 Nevada 35 39Arizona 200 4 New Hampshire 52 32Arkansas(20) 59 26 New Jersey New Jersey 258258 1 1California 87 19 New Mexico 91 18Colorado 20 43 New York (1) 150 5Connecticut 200 3 North Carolina 30 45Delaware (3) 24 41 North Dakota 44 34Florida 33.9 40 Ohio 55 29Georgia 37 36 Oklahoma 23 42Hawaii (30 130 7 Oregon 128 8Idaho 57 27 Pennsylvania 100 12Illinois (1) 98 17 Rhode Island 246Rhode Island 246 2 2Indiana 55.5 28 South Carolina 7 51Iowa 36 37 South Dakota 53 31Kansas 29 20 Tennessee (1)(2) 20 48Kentucky (2) 30 46 TexasTexas 141 141 1111Louisiana 36 37 Utah 69.5 23Maine 200 3 Vermont 119 10Maryland 100 12 Virginia (1) 30 47Massachusetts 151 4 Washington 203 3Michigan 200 5 West Virginia 55 29Minnesota 48 33 Wisconsin 77 21Mississippi 18 49 Wyoming60 25Missouri (1) 17 50 Dist. Of Columbia 100 12Montana 170 6 U.S. MedianU.S. Median 9090

Counties & cities may impose an additional tax on a pack ofcigarettes. Also, the federal tax is 39 centsfederal tax is 39 cents. NYCNYC has an additional $1.50 for a total cigarette pack price of $7.50pack price of $7.50.

30 states have increased cigarette taxes since January 1, 2002 some twice.

Every 10% increase reduces youth smoking by Every 10% increase reduces youth smoking by 7% and adult smoking by 2%.7% and adult smoking by 2%.

State Excise Tax on CigarettesState Excise Tax on Cigarettes

If you inherit $2 million dollars this If you inherit $2 million dollars this year, how much do you get to keep?year, how much do you get to keep?

2007

The Federal Estate Tax is disappearing.The Federal Estate Tax is disappearing.An estate is exempt from federal estate taxes if it’s below the An estate is exempt from federal estate taxes if it’s below the following thresholds. The Tax will disappear in 2010, only to following thresholds. The Tax will disappear in 2010, only to reappear in 2011. [tax of 55% on estates after the first reappear in 2011. [tax of 55% on estates after the first millionmillion] ]

IIf f you live you live in one ofin one of the gold states, the gold states, you might owe additional estate or you might owe additional estate or inheritance taxes, even after the inheritance taxes, even after the federal G’s death tax disappears.federal G’s death tax disappears.

$2 M tax free$2 M tax free

2008

2009

$2 M tax free$2 M tax free

$1 M tax free$1 M tax free

$3.5 M tax free$3.5 M tax free

No estate taxNo estate tax2010

2011

Revenues of Revenues of $2.407$2.407 Expenditures of Expenditures of $2.654$2.65420062006[Deficit of [Deficit of $248$248]]

Last SurplusLast Surplus

Causes: Wars

RecessionsRecessions Tax Cuts

Facts & Figures:

No political will

FFinancial inancial Price Price Of Of WarWarTotal Total CCost ost pperer

ConflictConflict CostCost PersonPersonWW1 $125 bil. $2,489WWII$600 bil. 20,388Korea 336 bil. 2,266Vietnam 494 bil. 2,204Gulf War I 76 bil. 306Gulf War II 438 bil.** 536** Cost over $12 Cost over $12 billion abillion a monthmonth

The War in Iraq has cost $16,000 per family.The War in Iraq has cost $16,000 per family.

300,000300,000 from the Afghanistan-Iraq wars suffer from from the Afghanistan-Iraq wars suffer from PTSDPTSD[Post-Traumatic Stress Disorder] or major depression that[Post-Traumatic Stress Disorder] or major depression thatwill cause the nation will cause the nation over $6 billion over $6 billion over two years.over two years.

20082008

91%91%

35%35%

91% on income over $200,00091% on income over $200,000

Top Marginal Tax RatesTop Marginal Tax RatesYearYear Tax RateTax Rate19001900 No Tax No Tax19141914 1% 1% [over $3,000][over $3,000]

[Only 1 in 270 paid this tax at all][Only 1 in 270 paid this tax at all]19301930 30% 30%[1 in every 32 [1 in every 32 was now payingwas now paying taxes] taxes]19401940 81% 81%[1 in every 3 was paying taxes][1 in every 3 was paying taxes]1943 1943 **Paycheck withholding Paycheck withholding (by (by the boss) was launched to stop cheating.the boss) was launched to stop cheating.

1950 [over $200,000] 91%1950 [over $200,000] 91%19701970 70% 70%[E[Everyoneveryone was paying was paying withwith taxable Y] taxable Y]19801980 70% 70%20002000 39.6 39.6%%

20082008 3535%%

Medicare taxMedicare tax – 1.45% for an individual [2.9% for self employed] for every dollar earned.Harrison FordHarrison Ford – received $25 million for 20 days work on a movie. 1.45% of $25 million = $362,500 x 2 = $725,000$725,000 medicare taxmedicare tax. [Over his 35 years on the Big Screen, his films grossed over $10 bil.Jim CarreyJim Carrey – gets $20 million per movie, so his tax is $580,000. [1.45% of $20 million = $290,000 x 2 = $580,000.]

[91% [91% for dollars overfor dollars over $200,000] $200,000]

Government FinanceGLOBAL PERSPECTIVE

Total Tax Revenue – Selected NationsPercent of Total Output-2004

SwedenDenmark

NorwayFinlandFrance

ItalyUnited Kingdom

GermanyCanada

AustraliaUnited States

JapanSouth Korea

10 20 30 40 50

Source: Organization for Economic Cooperation and Development

50.749.6

44.944.343.742.2

36.134.6

33.031.6

25.425.324.6

37%37%

57%57%

68%68%

85%85%

97%97%

3.3%3.3%

100100%%

90%90%

80%80%

70%70%

60%60%

40%40%

30%30%

20%20%

10%10%

TopTop1%1%

TopTop5%5%

TopTop10%10%

TopTop25%25%

TopTop50%50%

BottomBottom

5%5%

134 million filed tax returns butonly 90 million paid any taxes.Our average tax rate was 14%.

$61,

000

and

ove

r

$30,

000

and

ove

r

$99,

000

and

ove

r

$137

,000

+

$328

000

+

Suppose that every day, ten men go out for beerten men go out for beer and the bill for all tenbill for all ten comesto $100to $100. If they paid their bill the way we pay our taxespaid their bill the way we pay our taxes, it would go like thisgo like this:

The first four menfirst four men (the poorest) would pay nothingwould pay nothing.The fifth would pay $1fifth would pay $1.The sixth would pay $3sixth would pay $3.The seventh would pay $7seventh would pay $7.The eighth would pay $12eighth would pay $12.The ninth would pay $18ninth would pay $18. The tenth mantenth man (the richest) would pay $59would pay $59.

They realized that $20 divided by six is $3.33$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 fifth man and the sixth man would each end up being paid to drink his beerbeing paid to drink his beer.

So, that's what they decided to do. The ten men drank in the bar every day andseemed quite happy with the arrangement, until one day, the owner threw thema curve. 'Since you are all such good customers, he said, 'I'm going to reduce reduce the cost of your daily beer by $20the cost of your daily beer by $20. DrinksDrinks for the ten nowfor the ten now cost just $80cost just $80.The group still wanted to pay their bill the way we pay our taxesstill wanted to pay their bill the way we pay our taxes so the first first four menfour men were unaffected. They would still drink for freewould still drink for free. But what about the other six men - the paying customers? How could they divide divide the $20 windfall so that everyone would get his$20 windfall so that everyone would get his 'fair share?''fair share?'

So, the bar owner suggested that it would be fair to reduce each man's bill byreduce each man's bill by roughly the same amountsame amount, and he proceeded to work out the amounts each should pay.!  And so:The fifth manfifth man, like the first four, now paid nothingnow paid nothing (100% savings).The sixth now paid $2sixth now paid $2 instead of $3instead of $3 (33%savings33%savings). The seventh now pay $5 instead of $7seventh now pay $5 instead of $7 (28%savings28%savings).The eighth now paid $9 instead of $12eighth now paid $9 instead of $12 (25% savings25% savings)The ninth now paid $14 instead of $18ninth now paid $14 instead of $18 (22% savings22% savings)The tenth now paid $49 instead of $59tenth now paid $49 instead of $59 (16% savings16% savings). Each of the 6 was better off6 was better off than before. And the first 4 continued to drink for freefirst 4 continued to drink 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 mangot a dollar out of the $20,'declared the sixth man. He pointed to the tenth tenth man,' but he got $10!‘man,' but he got $10!‘'Yeah, that's right,' exclaimed the fifth man. 'I only saved a dollar, too. It's unfair that fifth man. 'I only saved a dollar, too. It's unfair that he got ten times more than I!‘he got ten times more than I!‘'That's true!!' shouted the 77thth man. 'Why should he get $10 back when I got only two? man. 'Why should he get $10 back when I got only two? The wealthy get all the breaks!''Wait a minute,' yelled the first four men in unison. 'We first four men in unison. 'We didn't get anything. The system exploits the poor!'didn't get anything. The system exploits the poor!'The nine men surrounded the tenth and beat him upnine men surrounded the tenth and beat him up.The next night the tenth man didn't show up for drinkstenth man didn't show up for drinks, so the nine sat down nine sat down and and had had beers beers without without himhim. When it was time to pay the billpay the bill, they discovered something important.They didn't have enough money between all of them for even half of the billdidn't have enough money between all of them for even half of the bill!And that is how our tax system workshow our tax system works. The people who pay the highest taxes get the most benefit from a tax reductionpeople who pay the highest taxes get the most benefit from a tax reduction. Tax them Tax them too muchtoo much, attack them for being wealthy, and they just may not show up anymorethey just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlierthey might start drinking overseas where the atmosphere is somewhat friendlier.

Highways [.20 a gallon]Highways [.20 a gallon]

STATE AND LOCAL FINANCESTATE AND LOCAL FINANCE

State ExpendituresState ExpendituresEducationEducationPublic WelfarePublic WelfareHealth and HospitalsHealth and Hospitals

Public SafetyPublic SafetyEducationEducation

36%36%Health & Hospitals 8%Health & Hospitals 8%

PublicPublicWelfareWelfare

25%25%Public Safety 5%Public Safety 5%

All Other18%

Highways 8%Highways 8%

Federal ExpendituresFederal Expenditures

Pensions and Income SecurityNational DefenseHealthInterest on Public Debt

Pensions &Pensions &Income SecurityIncome Security

35%35% NationalNationalDefenseDefense

20%20%

Health21%

All Other15%

Interest10%

2006 Data

Total Total ExpendituresExpenditures

$2,654$2,654 Billion Billion

Federal Tax RevenuesFederal Tax Revenues

PersonalPersonalIncome TaxIncome Tax

46%46%

PayrollPayrollTaxesTaxes38%38%

Corporate Income Tax 8%

All Other 4%All Other 4%

Excise Taxes 4%Excise Taxes 4%

Personal Income TaxPersonal Income TaxPayroll TaxPayroll TaxCorporate Income TaxesCorporate Income TaxesExcise TaxesExcise Taxes

2006 Data2006 Data

Total Tax RevenuesTotal Tax Revenues$2,407$2,407 billionbillion

Property Taxes & Other TaxesProperty Taxes & Other TaxesLicenses and OthersLicenses and Others

STATE AND LOCAL FINANCESTATE AND LOCAL FINANCE

State RevenuesState Revenues

Corporate Income TaxCorporate Income Tax

Sales and Excise TaxSales and Excise TaxPersonal Income TaxPersonal Income Tax

Sales &Sales &Excise TExcise Taxesaxes

48%48%StateState

PersonalPersonalIncome TaxIncome Tax

34%34%

Corporate Income Tax 7%Corporate Income Tax 7%Licenses & Others 6%Licenses & Others 6%

Property Taxes & Other Taxes 5%Property Taxes & Other Taxes 5%

States with No Income Tax (Red)States with No Income Tax (Red)*They tend to have more regressive tax systems.*They tend to have more regressive tax systems.

State, City, and County Sales TaxState, City, and County Sales Tax

STATE AND LOCAL FINANCESTATE AND LOCAL FINANCE

Local RevenuesLocal Revenues

Property TaxesProperty Taxes74%74%

Personal & Corporate Income Taxes 6% All Other 4%

Sales &ExciseTaxes16%

PersonalPersonal & & CorporateCorporate Income Taxes Income Taxes

Sales and Excise TaxesSales and Excise TaxesProperty TaxesProperty Taxes

National Debt History$9.4 Tril.$9.4 Tril.

National Debt History[adjusted for inflation in 2000 dollars]

$9.4 Tril.$9.4 Tril.

Except for WWII, the deficitExcept for WWII, the deficitstayed pretty constant forstayed pretty constant forabout 40 years until 1983about 40 years until 1983

PUBLIC DEBT OWNERSHIP, 2006PUBLIC DEBT OWNERSHIP, 2006[This is held both privately and publicly][This is held both privately and publicly]

9%

42%

8%

25%

8%8%

Debt held by the Fed Debt held by the Fed & Gov. Agencies [51%]& Gov. Agencies [51%]

Debt held outside the Debt held outside the Federal Gov and Fed Federal Gov and Fed

[49%][49%]

Federal Reserve

U.S.Government

Agencies

Other, IncludingState & Local Governments

U.S. Banks & FinancialInstitutions

Foreign Ownership

U.S. Individuals

Foreigners hold $1.9 TrillionJapan-$582 B, China-$500 B,Britain-$266 B, OPEC-$126 B, S. Korea-$46 B, H. Kong–$56 B, Taiwan-$53 B, Singapore-$24 B, Thailand-$13 B, & India-$13 B.World Total: $2,247World Total: $2,247

51%51%

49%49%

The “no”“no” answer entails three pointsentails three points.1. RefinancingRefinancing – as portions of the debt fall due each month, the G does not cut G or raise T to retire the maturing bonds. It refinances the debtrefinances the debt by selling new bonds and uses the proceeds to pay off holders of the maturing bonds.2. 2. TaxationTaxation – if bankruptcy were imminent the G could always raise taxes.3. Creating MoneyCreating Money – bankruptcy could be avoided by printing the money (inflationaryinflationary).

Economic Implications of the Debt: False IssuesEconomic Implications of the Debt: False Issues[The “G”“G” doesn’t have to pay the entire debt off because it never “dies.”“dies.”]

[The “G”“G” will live forever so it will keep “rolling it over in perpetuity”“rolling it over in perpetuity”]

Going Bankrupt?Going Bankrupt?

Shifting BurdensShifting Burdens Does every new born get slapped on the backside, then told he owes $33,000owes $33,000?Not quite. About 82% of the debt is owed to ourselves82% of the debt is owed to ourselves. Thus the public debt is apublic debt is aa public credita public credit. It is a liability to the taxpayerliability to the taxpayer but an asset to the peopleasset to the people (bondholdersbondholders). Therefore, retiring the debt would amount to a large transfer paymentretiring the debt would amount to a large transfer payment from U.S. U.S. citizens to U.S. citizenscitizens to U.S. citizens. The repayment would entail no decrease in the economy’swealth or standard of living. So the babies who inherit $33,000 worth of debt willbabies who inherit $33,000 worth of debt willinherit almost that same amountinherit almost that same amount.

Whew! $33,000 each.Whew! $33,000 each. I’m not paying no $33,000.

• Pay Down the Public DebtPay Down the Public Debt

• Reduce TaxesReduce Taxes

• Increase Government SpendingIncrease Government Spending • BBolster Social Security Trust Fundolster Social Security Trust Fund

• Combination of these PoliciesCombination of these Policies

Crowding-outCrowding-out effect in an Open Economy[Xn are crowded-out, decreasing AD]

1. Federal Government

deficits

2. High real U.S. interest

rates

3. Decline indomestic inv.(crowding-out)

4. Increasedforeign demandfor U.S. bonds

5. IncreasedU.S. external

debt

6. Increasedinternational

value of dollar

7. U.S.Exportsdecrease

8. U.S.Importsincrease

10.Tradedeficits

9. Decrease in Xn decr AD

This is the way we used to get the first cry out of a babyfirst cry out of a baby.

Now we tell them, “You“Youoweowe $33,000.”$33,000.” (as theirshare of the National Debt)

We get the same result –their first crytheir first cry; no more of that “Take that.”“Take that.”

We no longer have to hit our newborn to get their first cry.

““Take Take That!That!

The Debt prevents The Debt prevents me from having to me from having to do this.do this.

Debt and Deficit NS 1-6Debt and Deficit NS 1-61. The (national debt/federal budget deficit) consists of the accumulation of all Federal government deficits & surplusesFederal government deficits & surpluses.2. The (national debt/budget deficit) is found by subtractingsubtracting ““G” tax revenues from government spendingG” tax revenues from government spending in one year. 3. How much is the National DebtNational Debt now? _________4. If “G” adhered strictly to an annually balanced budgetannually balanced budget, G’s budget would tend to (stabilize/destabilize) the economy.5. The idea of increasing T during good timesincreasing T during good times & decreasingdecreasing them during bad timesthem during bad times [recessions] [over the course of the business cycle, the budget would be balanced] is the (annually/cyclical) balanced budget.6. The philosophy of functional financefunctional finance is the idea that the main function of the budget is to (stabilize/destabilize) the economy & balancing the budget every year is of (little/extreme) importance.

$9.4 trillion$9.4 trillion

Debt and Deficit NS 7-11Debt and Deficit NS 7-11 7. Budget deficitsBudget deficits were smaller during the

(1970s/1980s & early 1990s)

8. Between 1980 & 19961980 & 1996 the public debt (grew/did not grow) absolutely and as a percentage of GDP.

9. The largest proportion of the public debtlargest proportion of the public debt is held by (foreigners/American public). Therefore we (can/can not) say the public debt is a public credit.

10. The “crowding-out effect”“crowding-out effect” suggests that increases in G spending financed thru borrowing will (increase/decrease) the interest rate and (increase/decrease) private investment.

11. The most likely way the public debt imposes a burden on public debt imposes a burden on future generationsfuture generations is by reducing the current level of (employment/capital accumulation), thus giving us a smaller “national factory.”

Debt and Deficit NS 12-14Debt and Deficit NS 12-1412. Large budget deficitsbudget deficits (increase/decrease) domestic

interest rates, (increase/decrease) the international value of the dollar, and (increase/decrease) American net exports which (enhance/diminishes) expansionary fiscal policy.

13. The line-item vetoline-item veto would have permitted the president to (add/delete) individual projects and programs from larger appropriation bills.

14. The (GDP/GNP/GRH) was a program designed to balance program designed to balance the budgetthe budget.

Money, BMoney, Bankinganking, Money C, Money Creationreation, , Monetary Policy, Extending AS, Monetary Policy, Extending AS, Macro DMacro Disputesisputes, Debt , Debt and and DeficitDeficit

1. What is the monetary rulemonetary rule?2. If a household spends $100,000 per year, & on average holds a money balance of $20,000, their velocityvelocity of money is ____.

oo

ASAS11

PL1[3PL1[3%%]]

PL2[8PL2[8%%]]

YY11 YY22

aa22

aa11

ASAS22

bb11

LRASLRAS

HHigher igher PL PL results inresults in higher nominal higher nominal wages & shifts SRAS left.wages & shifts SRAS left.

Inflat.Inflat.GapGap

Output & employment increasedOutput & employment increasedin the SR but not the LR.in the SR but not the LR.

3. An unanticipatedunanticipated increase in PL will lead to (lower/higher) product prices, (decr/incr) in

profits & a(an) (decr/incr) in unemp. in SRSR.

4. With the unanticipatedunanticipated increase inincrease in PLPL - output & employment did (incr/decr) in the SRSR but (decreased/increased/stayed the same) in the LRLR.

Increase the MS 3-5% a yearIncrease the MS 3-5% a year

55

ADAD11

ADAD22

5. The two main variants of the natural rate hypothesistwo main variants of the natural rate hypothesis are (RATEX/Keynesian/Adaptive Expectations/Reaganomics).

6. According to the MonetaristsMonetarists, the investment demand curveinvestment demand curve is more (flat/vertical) and the money demand curvemoney demand curve is more (flat/vertical). 7. Does the economy self-correct if prices are flexible butprices are flexible but wages are notwages are not? _______nono

KeynesianKeynesian cause-effect chain cause-effect chain MonetaristMonetarist cause-effect chain cause-effect chain

8. An unanticipatedunanticipated increase in AD would result in output (incr/decr/stay same) in SRSR, but (incr/decr/stay same) in LRLR.9. An anticipatedanticipated increase in AD would result in Y (incr/decr/

stay the same) in the SRSR and (incr/decr/stay the same) in the LRLR.

o

SRASSRAS11

PLPL1[1[33%]%]

PLPL2[2[66%]%]

YY11 YY22

EE22

EE11

SRASSRAS22

Pri

ce L

evel

RDO

Inflati.Inflati.GapGap

Y & employment increasedY & employment increasedin the SR but not the LR.in the SR but not the LR.

E3

LRASLRAS

ADAD22

ADAD11

00

PL2[1%]PL2[1%]

YYRR

ASAS11

PLPL11[3%][3%]

YY**

aa33

aa11

ASAS33

cc11

LRASLRAS

Real domestic outputReal domestic output

Lower PLLower PL reduces nominal wages & shifts reduces nominal wages & shifts SRAS rightSRAS right..

Recess.Recess.GapGap

Y & employment decreasedY & employment decreasedin the in the SRSR but not the but not the LRLR..

10. In the LRLR, a decline in inflationdecline in inflation will (incr/decr/not affect) output & employment.

11. If decline in inflationdecline in inflation is anticipatedanticipated, Y/empl.

will (increase/decrease/not change) in SRSR. [or LRLR]

ADAD11

ADAD22

12. An annually balanced budgetannually balanced budget is is pro-cyclicalpro-cyclical because tax revenue reductions associated with recessionrecession will require (increases/decreases) in G spending or increases in taxes.

13. Proper monetary policy monetary policy duringduring inflationinflation is (raise, raise, sell/ lower, lower, buy) Discount Rate, RR, & bonds.

14. An increase increase in thein the MS MS will lead to a(an) (increase/decrease) in the interest rate & (decrease/increase) AD.15. “Crowding out”“Crowding out” is something the

Keynesians/Monetarists) believe strongly in.16. Selling bondsSelling bonds by the Fedby the Fed would result in a (smaller/larger)

MS and (lower/higher) interest rates.17. If you are estimating your expensesestimating your expenses for the prom at $800$800,

then you are using money as (unit of account/medium exchange/store of value).

18. Foreign individuals and governmentsForeign individuals and governments (hold/do not hold) most of the Public DebtPublic Debt.

19. Fiscal policyFiscal policy is thought to work best at fighting (inflation/

depressions) and monetary policymonetary policy is thought to work best

at fighting (inflations/depressions).

20. The Laffer curveLaffer curve was a cornerstone of

(RATEX/Supply-side/ Keynesians) economics.

21. The tight money cause-effect chaintight money cause-effect chain is (incr/decr) the MS, which would (incr/dec) the interest rate, which would (incr/decr) Ig, which would (incr/decr) AD and GDP.

22. The easy money cause-effecteasy money cause-effect chainchain is (incr/decr) the MS, which would (incr/decr) the interest rate, which would (incr/decr) Ig, which would (incr/decr) AD and GDP

23. The (Monetarists/New Keynesians) are advocates of advocates of monetary and fiscal policymonetary and fiscal policy.

24. An easy money policyeasy money policy will cause the dollardollar to (apprec/deprec) and cause American Xn to (incr/decr).

25. A tight money policytight money policy will cause the dollardollar to (apprec/deprec) and cause American net exportsnet exports to (increase/decrease).

26. A bank loan from the Fedbank loan from the Fed will (increase/decrease/not affect) RR, but (increase/decrease/not affect) ER and therefore TR.

27. A bank deposit by thebank deposit by the publicpublic will (increase/decrease) RR,ER, & TR.

28. RATEXRATEX are strong advocates that the public’s expectations

(strongly influence/negate) fiscal and monetary policy.

29. The intellectual roots of monetarismintellectual roots of monetarism are based on (Classical/Keynesian) economics.

30. An adherence with an adherence with an annually balanced budgetannually balanced budget would (stabilize/destabilize) the economy.

31. If there is a decrease in AD and prices are not flexibleprices are not flexible, the resulting recessionrecession will be worse because equilibrium price levelequilibrium price level will be (lower/higher) than with flexible prices.

32.In the SSRRPPCC, there (is a/is no) tradeoff between inflation & output, and in the LRPCLRPC there (is a/is no) tradeoff between inflation and unemployment.

33. The (SSRRPPCC/LRPCLRPC) is consistent with the stablestable traditional Phillips traditional Phillips curvecurve.

Extra PracticeExtra Practice MSMS = = CurrencyCurrency + + DDDD of of PUBLICPUBLICRR RR is is 25% Assets25% Assets DDDD(Liabilities)(Liabilities) TR[RR+ER]=$100 TR[RR+ER]=$100 mil.mil. $400 million $400 million

1. How much can this bank loan out? $______1. How much can this bank loan out? $______2. If Christina A. Christina A. puts __________________ in this bankbank(DDDD), ER will increase by $$_______.

3. Possible Money Creation in the system could be $$________.

4. Potential Total Money Supply could be as much as $$_________.

00

7,5007,500

30,00030,000

40,000 40,000

$10,000$10,000

Extra PracticeExtra Practice MS = Currency + DD of PUBLICRR RR is is 25% Assets 25% Assets DDDD (Liabilities)(Liabilities)

TR[RR+ER] = TR[RR+ER] = $100 mil.$100 mil. $400$400 million million

5. How much can Christina’s How much can Christina’s bankbank loan out? $______ loan out? $______6. If Christina’s Bank Christina’s Bank borrows $10,000 from the FedFed ER will increase by $$_______.

7. Possible Money Creation in the system could be $$_________.

8. Potential Total Money Supply could be as much as $$__________.

FedFed

00

10,00010,000

40,00040,000

40,000 40,000

Christina’s BankChristina’s Bank

34. If the RR is 50% and the FedFed buys $100 M of bonds from the PUBLIC PUBLIC [Kate][Kate], then the MSMS is increased by _______. ER are increased by ______. PMC is _______. TMS would be ______.35. RR is 40% and the Collins BankCollins Bank borrows $100 M from the FedFed. As a result, RR are increased by ______. ER is increased

by _______. PMC and TMS is increased by ________.36. Your bankbank has DDDD of $200,000$200,000 and the RR is 50%. If RR and ER are equal, then TR are _______.37. The Buzon BankBuzon Bank has ER of $75,000 & DD is $100,000. If the

RR is 20%, TR are _________.38. RR is 10% & the FedFed buys $10 million of bonds from the PUBLICPUBLIC [Mary] [Mary]. The MSMS is increased by _______. ER are increased

by _______. PMC is _______. TMS would be _________.

$100 M$100 M$50 M$50 M $100 M$100 M $200 M$200 M

$100 M$100 M $250 M$250 M

$200,000$200,000

$95,000$95,000

$10 M$10 M

$9 M$9 M $90 M$90 M $100 M$100 M

00

BanksBanks PUBLICPUBLIC FedFed

1. If the RR is 40% and the FedFed buys $100 M of bonds from the PUBLICPUBLIC [Ann] [Ann], then the MSMS is increased by _______. ER are increased by ______. PMC is _______. TMS would be ______.2. RR is 50% and the Boase BankBoase Bank borrows $100 M from the FedFed. As a result, RR are increased by ______. ER is increased

by _______. PMC and TMS is increased by ________.3. Your bankbank has DDDD of $400,000$400,000 and the RR is 25%. If RR and ER are equal, then TR are _______.4. The Palmer BankPalmer Bank has ER of $60,000 & DD is $200,000. If the RR is 20%, TR are _________.5. RR is 20% & the FedFed buys $50 million of bonds from the PUBLICPUBLIC [Marie] [Marie]. The MSMS is increased by _______. ER are increased by _______. PMC is _______. TMS would be _________.

$100 M$100 M$60 M$60 M $150 M$150 M $250 M$250 M

$100 M$100 M $200 M$200 M

$200,000$200,000

$100,000$100,000

$50 M$50 M

$40 M$40 M $200 M$200 M $250 M$250 M

00

BanksBanks PUBLICPUBLIC FedFed

Money Creation FormulasMoney Creation Formulas[[MSMS = = CurrencyCurrency + + DDDD of of publicpublic]]

No PublicNo Public: [: [FedFed gives $1.00 loan to agives $1.00 loan to a bankbank]]1.1. ER x MER x MMM = = PMCPMC & & TMSTMS

PublicPublic RRRR ++ ERER == TRTRTR - RR = ERTR - RR = ERTR - ER = RRTR - ER = RR

PublicPublic:: Student Student depositsdeposits $1.00$1.00 in ain a bankbank1. ER ER [[DDDD-RR] -RR] x Mx MMM = = PMCPMC2. PMCPMC + 1 + 1stst DDDD = =TMSTMS

FedFed