chapter 30 financing government taxes and debt gottheil — principles of economics, 7e © 2013...

Chapter 30Chapter 30

FINANCING GOVERNMENT FINANCING GOVERNMENT Taxes and DebtTaxes and Debt

Gottheil — Principles of Economics, 7e© 2013 Cengage Learning1

Economic PrinciplesEconomic Principles

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e2

Commandeering resources

Commandeering money (taxes)

Regressive, proportional, and progressive tax structures

Economic PrinciplesEconomic Principles


Social Security taxes

Government securities and public debt

Internally and externally financing the debt


EXHIBIT 1 PRODUCTION POSSIBILITIES CURVE

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.

Commandeering ResourcesCommandeering Resources


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

resources.



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.



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.

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.

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


Poll tax

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



Regressive 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.



1. What is an example of a regressive income tax?

• One example is a poll tax.



1. 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.



Proportional income tax

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



2. An example of a proportionate income tax is?

• A flat-rate tax on personal income



Progressive 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.



3. What is an example of a progressive income tax?

• The current system of federal income taxation is progressive.



Corporate income tax

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

Are We Really Paying High Taxes?Are We Really Paying 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



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

True or false: Taxes as a percentage of GDP are higher in the U.S. than in any other rich industrialized country.



• 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.

True or false: Taxes as a percentage of GDP are higher in the U.S. than in any other rich industrialized country.



Property tax

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



Unit tax

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



Sales tax

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



Customs duty

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



Excise tax

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



4. Complete the following sentence:

All excise taxes are ______.



4. Complete the following sentence:

All excise taxes are regressive.



5. 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



6. True or false: In any given year, Social Security taxes collected by the government equal the Social Security payments that the government makes.

• False. The surplus funds are invested in government bonds, which pay interest to the Social Security system.


EXHIBIT 2 2006 TAX RATE SCHEDULE FOR MARRIED PERSONS FILING JOINTLY

Source: Internal Revenue Service, Instructions for Form 1040 (Washington, D.C.: Department of the Treasury, 2006).

Exhibit 2: 2006 Tax Rate Schedule for Exhibit 2: 2006 Tax Rate Schedule for Married Persons Filing JointlyMarried Persons 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.



• 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?



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




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




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



EXHIBIT 3 FEDERAL, STATE, AND LOCAL GOVERNMENT REVENUES: 2007 ($ BILLIONS)

Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, August 2008).

Exhibit 3: Federal, State, and Local Exhibit 3: Federal, State, and Local Government Revenues: 2007Government Revenues: 2007


Complete the sentence:

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

Exhibit 3: Federal, State, and Local Exhibit 3: Federal, State, and Local Government Revenues: 2007Government Revenues: 2007


Complete the sentence:

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


EXHIBIT 4 FEDERAL GOVERNMENT’S SURPLUSES AND DEFICITS AND AS PERCENT OF GDP:

1990–2007 (in constant 2000$)

Source: Statistical Abstract, The United States: 2006 (Washington, D.C.: U.S. Department of Commerce, 2008).

Exhibit 4: Federal Government’s Exhibit 4: Federal Government’s Surpluses and Deficits and as Surpluses and Deficits and as

Percent of GDP: 1990–2007Percent of GDP: 1990–2007


True or false: The federal government ran a budget surplus during the years between 1990 and 2007.• False. The federal government ran a budget

deficit during that time period.

Financing Government Financing Government Spending Through DebtSpending Through Debt


Public debt

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


EXHIBIT 5 OWNERSHIP OF THE U.S. PUBLIC DEBT: 2010 (percentage of total)

Source: Federal Reserve Bulletin (Washington, D.C., September 2011).

Exhibit 5: Ownership of the U.S. Exhibit 5: Ownership of the U.S. Public Debt: 2010Public Debt: 2010


Which of the following correctly identifies the top two owners of the U.S. public debt:a. Depository institutionsb. Federal Reserves and intergovernmental

holdingsc. Foreigners

Exhibit 5: Ownership of the U.S. Exhibit 5: Ownership of the U.S. Public Debt: 2010Public Debt: 2010


Which of the following correctly identifies the top two owners of the U.S. public debt:a. Depository institutionsb. Federal Reserves and intergovernmental

holdings and foreignersc. Pension funds

Financing Government Sending Financing Government Sending through Debtthrough Debt


Which form of federal government debt is sold in denominations as low as $1,000 and carry maturities of 2 to 10 years?• U.S. Treasury notes

Tracking Government DebtTracking Government Debt


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


EXHIBIT 6A THE FEDERAL DEBT

Source: Statistical Abstract of the United States, 2006 (Washington, D.C.: U.S. Department of Commerce, 2006).


EXHIBIT 6B THE FEDERAL DEBT

Source: Statistical Abstract of the United States, 2006 (Washington, D.C.: U.S. Department of Commerce, 2006).

Exhibit 6: The Federal DebtExhibit 6: The Federal Debt


1. During what time period did the gross federal debt grow most rapidly?

• During the period between approximately 1980 and 2005



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.



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.



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.




• In order for debt as a percentage of GDP to flatten out when debt is still growing, GDP must grow as fast as debt.




• In the late-1990s gross federal debt actually began to decline.


EXHIBIT 7 GROSS PUBLIC DEBT AS A PERCENT OF GDP FOR SELECTED ECONOMIES: 2007

Source: The 2008 World Factbook, 2008.

Exhibit 7: Gross Public Debt as Exhibit 7: Gross Public Debt as a Percent of GDP for Selected a Percent of GDP for Selected

Economies: 2007Economies: 2007


What does Exhibit 7 suggest about the U.S. debt ratio of 65.7 percent GDP compared to other countries?• It is not out of line and even and is a

near match of France’s and Germany’s.

Hatred of Tax Collection is the Hatred of Tax Collection is the Way of the WorldWay of the World


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

b. France

c. Russia

Does Debt Endanger Future Does Debt Endanger Future Generations?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.



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.



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



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



External debt

• Public debt held by foreigners.



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.

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.



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.



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.



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



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.

The Aftermath of the 2008 FinancialThe Aftermath of the 2008 FinancialMeltdownMeltdown


The president, aided by an obliging Congress, sought to pull the economy out of its doldrums by incurring record-setting deficits which raised the public debt level above $13 trillion by 2010.

chapter 30 financing government taxes and debt gottheil — principles of economics, 7e © 2013...

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regressive income tax

progressive income tax

proportional income

tax system

corporate income tax

proportionate income

consumption tax

tax revenues