chap007-the government sector

8/14/2019 Chap007-The Government Sector

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Chapter 7

The Government Sector

7-1Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.


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Objectives

Government spending

The graphing of the C + I + G line

Types of taxes

The average and marginal tax rates

Sources of government revenue Principles of taxation

The economic role of government



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Introduction: The Growing

Economic Role of Government Most of the growth over the past seven decades

was due to the Depression and World War II

Since 1945 the roles of government at the

federal, state, and local levels have expanded The seeds of that expansion were sown during theRoosevelt administration

The government exerts four basic influences

It spends more than $3.0 trillion It levies even more in taxes

It redistributes hundreds of billions of dollars

It regulates the economy



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7-6

State and Local Government

Spending Main expenditures

Education

HealthWelfare

Spending is a little more than half the

level of federal spending Police protection and prisons are now

straining state and local budgets

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.


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Government Purchases versus

Transfer Payments The federal, state, and local governments

spends over $3.0 trillion a year

GDP = C + I + G + XnApproximately half are transfer payments

The largest transfer payment is social security

These payments end up in the C part GDP

Approximately half are governmentpurchases

The largest government purchase is defense

These end up in the G part of GDP



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Graphing the C + I + G Line


To keep the graph as

simple as possible, we are

assuming the government

spends a constant amount

of money regardless of the

level of disposable income


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Graphing the C + I + G Line


How much is G?

Answer: 2000


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The Average Tax Rate and the

Marginal Tax Rate

Income Marginal Total AverageLevel Tax Rate Tax Taxes Tax Rate

7-10

This is a hypothetical illustration



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Marginal Tax Rate


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0 - $100 0 % 0 $ 0 0.0 %



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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 $10



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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 $10

Additional Taxes Paid ( $10)

MTR = -------------------------------- ----------

Additional Taxable Income ($100)



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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 10 % $10


MTR = -------------------------------- ----------

Additional Taxable Income ($100)



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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 10 % $10


MTR = -------------------------------- ----------

Additional Taxable Income ($100)The Marginal Tax Rate (MTR) is the rate you pay on the last

dollars you earned



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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 10 % $10 $10



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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 10 % $10 $10

Total Taxes Paid ( $10)

ATR = -------------------------------- ----------

Entire Income ($200)



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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 10 % $10 $10 5.0 %


ATR = -------------------------------- ----------




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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 10 % $10 $10 5.0 %


ATR = -------------------------------- ----------




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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 10 % $10 $10 5.0 %


ATR = -------------------------------- ----------


The Average Tax Rate (ATR) is the overall rate you pay on

your entire incomeCopyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.


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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 10 % $10 $10 5.0 %

$201 - $300 12 % $12 $22 7.3 %



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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 10 % $10 $10 5.0 %

$201 - $300 12 % $12 $22 7.3 %

$301 - $400 15 % $15 $37 9.3 %



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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 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 %



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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 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 %



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Marginal Tax Rate


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0 - $100 0 % $ 0 $ 0 0.0 %

$101 - $200 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 %

> $600 80 %Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.


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Types of Taxes

Direct tax

A tax with your name on it

Indirect tax

A tax on things



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Types of Taxes

Progressive taxes

Places a greater burden on those best able to pay

and little or no burden on the poor Proportional taxes

Places an equal burden on the rich, the middle class,

and the poor

Regressive taxes Places a heavier burden on the poor than on the rich



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Nominally Progressive,

Proportional, and Regressive

Taxes

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 7-28


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Sources of Federal Revenue

Personal Income TaxThe personal income tax is the largest source

of federal revenueAccounts for 44 percent of all federal tax

revenue

Low income people pay little or no federal

income tax This means in general the middle class and the

rich pay nearly all federal taxes



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Federal Personal Income Tax:The Top Marginal Tax Rate, 1954-2006


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Top Marginal Tax Rates


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The Personal Income tax

Individual personal income taxes account for

44 percent of all federal tax revenue In general, the middle class and the rich pay

nearly all federal income taxes

The federal personal income tax is considered

progressive because the burden falls mainly on

the upper middle class and the rich



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The Social Security and Medicare taxes are thePayroll 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 $94,200

The inflation rate of the previous year raises the wage base

The Medicare tax of 1.45% applies to all wagesand salaries. There is no wage based limitation.Income such as rental income, interest,dividends, and profit is exempt



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You pay 6.2% in payroll tax on wages up to

$94,200 and 1.45% on all wagesand 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 thefastest growingsource 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



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Level of Earned Income Taxes Paid Average Tax Rate

$ 10,000 $ 620.00 6.2%

94,200 5,840.40 6.2%

100,000 5,840.40 5.84%

1,000,000 5,840.40 0.58%

The Incidence of the Social Security Tax at Various

Income Levels

Note: The current social security tax by law is set at6.2% with a wage based limitation of $94,200


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The Corporate Income Tax

The corporate income tax is a tax on acorporations profits The maximum rate is 35%, however loopholes allow

most corporations to pay significantly lower ratesthan the maximum rate

Corporate income taxes are just 3% of all federaltax revenue

All corporations earning profits of at least

$335,000 are to pay an average tax rate of 35% But loopholes in the tax law allow many

corporations to pay much lower taxes



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Excise Taxes

An excise tax is a sales tax aimed atspecific goods and services

Accounts for about 4 percent of federalrevenue

Most excise taxes are levied by thefederal government

State and local governments often levy taxeson the same items



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Excise Taxes

Excise taxes tend to reduce consumption

of certain products of which the federal

government takes a dim view Excise taxes are usually regressive



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The Estate Tax

The estate tax is a tax on the estates of

people when they die

It is a graduated tax that rises to 55% It is levied only on estates valued at $1,000,000 or

more

More than 90% of estate taxes are paid by

people with incomes above $200,000 a year

at the time of death



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Sources of State and Local Tax

Revenue Personal income tax

Accounts for about half of all state revenue

Sales Tax Is a source of almost half of all taxes collected by the

states

Is a highly regressive tax

Property taxes Provides 80 percent of all local tax revenue Can influence business decisions about where to

locate



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The State and Local Fiscal

Dilemma Since World War II, state and local governments have

been expected to provide an increasing number ofservices Most notable are health, welfare, education, police protection

and prisons In 2003 states increased tuition at public colleges, cut

Medicaid eligibility and benefits, and laid off stateemployees In addition localities spent billions of dollars on new security

measures without receiving any federal assistance Unfunded mandates

The Federal government often places obligations on stateswithout providing the money to pay for them


Th St t d L l Fi l


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Neighboring states and local

governments are in direct competition

with one another for tax dollarsIf one governments tax rates rise too far

above the levels of its neighbors, it citizens

will vote with their feet

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The State and Local Fiscal

Dilemma



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Government Tax Rates as a Percentage of GDP, 1929 and 2005

Economic Report of the President, 2003

Tax Rates are about

two and a half times as

high as they were in

1929

Tax Receipts as a Percentage of GDP in the United States and


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Tax Receipts as a Percentage of GDP in the United States and

Selected Western European Countries, 2004

Organization for Economic Cooperation and Development


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Economic Role of Government

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Provision of Public Goods and Services

Redistribution of Income

Stabilization

Economic Regulation



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Provision of Public Goods and

Services Some examples

Defense of the country

Maintenance of internal orderA nationwide highway network

Provision of a money supply

Public education

Running the criminal justice system

Environmental protection



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Redistribution of Income

The government does redistribute hundreds ofbillions 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 taxbreaks for defense contractors, oil companies, and otherlarge corporations



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Stabilization

Two basic goals of the federal

government

Stable prices with little or no inflationLow unemployment

An economic rate of growth high enough to keep

the unemployment rate to a minimum



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Economic Regulation

The government provides the economic rules of

the game

This must be done within the social and politicalcontext in which the economy operates

The government must allow individuals and business firms

to operate with the maximum degree of freedom

There is little agreement as to how far economic freedom

may be extended without interfering with society as awhole or the economic rights of specific individuals or

business firms



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Adam Smiths Dos and Donts

Do

Protect society from the violence and

invasion of other countriesEstablish an exact administration of justice

Erect and maintain certain public works and

institutions where private enterprise couldnot profit from doing so

Dont do anything else



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Conclusion

Until the 1930s, the federal government more

or less followed the role prescribed by Adam

Smith The governments economic role has expanded

tremendously these last seven decades

It will probably continue to grow into an even

more monolithic all-powerful colossal Big-Brother in the coming years


i S i S i


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Will Social Security

be There for You?

Currently, the federal government is receiving $150million more in Social Security Taxes than it is payingout This surplus is deposited in the Social Security trust (trust me)

fund How ever, the surplus is spent by the government each year tooff set its deficits

The US Treasury places I.O.U.s, (government securities) in theSocial Security trust fund

In essence, the right hand (general fund) gives the left hand

(social security trust fund) an I.O.U. and spends the money

This fund consist consists of trillions of dollars of governmentsecurities (I.O.U.s . . . they have been doing this for decades)




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be There for You?

The Looming Crises In 2011, the baby boomers (born between 1946 and

1964) will be retiring

This means the annual social security surplus which

is being spent by the government and replaced by anI.O.U. will disappear

Social Security checks will then have to be paid out

of the governments general fund

The government will have to make good on its I.O.U.s byselling the government securities in the social security trust

fund (borrowing the money)

However, the trust fund I.O.U.s will run out around 2042!




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be There for You?

The Looming Crises The government will borrowing hundreds of billionsof dollars by selling the government securities in thetrust fund (I.O.U.s) to pay social security recipients

Selling government securities is simply borrowing money

from the people who buy them These I.O.U.s will be gone by 2042

Financing the social security system by borrowingmoney will be on top of financing an already hugeand growing federal budget deficit

This will push up interest rates and possiblyprecipitate a financial collapse of unprecedentedproportions unless strong measures are taken nowto raise social security taxes and lower benefits


Social Security is the Good News


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Social Security is the Good News

the Bad News is Medicare

Medicare is even more seriously underfunded than Social Security

By 2018 Medicare spending will surpass

Social Security spendingRemember all those retiring baby boomers?

Medicare is much more complex than

Social Security



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Big government, like rock n roll, is here to stay.

But can the politicians song and dance match

Medicare & Social Securitys tunes?

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