Section 9.1 – economic impact of taxes
- When a tax is placed, the good or service raises the cost of production and the price of the product
- With less products sold, resources has to be cut from a business
- Can be used to encourage/discourage certain types of activities
- Sin tax – relatively high tax designed to raise revenue and discourage consumption of a socially undesirable product
- Can affect productivity and economic growth by changing the incentives to save, invest, and work
- Incidence of a tax – final burden of a tax
Criteria for effective taxes
- Equity, taxes should be impartial and just
- Tax loopholes – exception or oversight in tax law allowing a taxpayer to avoid paying certain taxes
- Simplicity, both taxpayers and tax collectors can understand them
- Individual income tax – federal tax levied on the wages, salaries, and other income of individuals
- Sales tax – general state or city tax levied on a product at the time of sale
- Efficiency – relatively easy to administer and reasonably successful at generating revenue
- Tax return – annual report by a taxpayer filed with the local, state, or federal government detailing income earned and taxes owned
Two principles of taxation
- Benefit principle of taxation – belief that taxes should be paid according to benefits received regardless of income
- Limitations: those who receive government services may be the ones who can least afford to pay for them; benefits are often hard to measure
- Ability to pay principle of taxation – belief that taxes should be paid according to level of income, regardless of benefits received
Three types of taxes
- Proportional tax – tax in which the percentage of income is the same regardless of the level of income
- Average tax rate – total taxes paid divided by the total taxable income
- Medicare – federal health care program for senior citizens
- Progressive tax – tax in which the percentage of income paid in tax rises as the level of income rises
- Marginal tax rate – tax rate that applies to the next dollar of taxable income
- Regressive tax – tax in which the percentage of income paid in tax goes down as income rises
Section 9.2 – federal, state, and local revenue systems
- Internal revenue service – branch of the US treasury department that collects taxes
Federal government revenue sources
- Payroll withholding system – system that automatically deducts income taxes from paychecks on a regular basis
- Indexing – adjustment of the tax brackets to offset the impact of inflation
- FICA – Federal insurance contributions act; tax levied on employers and employees to support social security and Medicare
- Payroll tax – tax on wages and salaries deducted from paychecks to finance social security and Medicare
- Borrowing by the federal government is the third-largest source of federal revenue
- Corporate income tax – tax on corporate profits
- Excise tax – general revenue tax levied on the manufacture or sale of selected items
- Estate tax – tax on the transfer of property when a person dies
- Gift tax – tax paid by the donor on transfer of money or wealth
- Customs duty – tax on imported products
- User fee – fee paid for the use of a good or service
State government revenue sources
- Intergovernmental revenue – funds that one level of government receives from another level of government
- Most states have implemented sales taxes to add to their revenue
Local government revenue sources
- Property tax – tax on tangible and intangible possessions such as real estate, buildings, furniture, stocks, bonds, and bank accounts
- Tax assessor – person who examines and assesses property values for tax purposes
- Natural monopolies – market structure in which average costs of production are lowest when a single firm exists
Chapter 10.1 – the economics of government spending
- Pork – a line-item budget expenditure that circumvents normal budget procedures and benefits a small number of people or businesses
Government spending in perspective
- Public sector – the part of the economy made up of local, state, and federal governments
- Public opinion gave government a larger role in everyday economic affairs
- Massive government spending funded the united states involvement in world war ii
- Private sector – that part of the economy made up of private individuals and businesses
- Transfer payment – payment for which the government receives neither good nor services in return
- Grant in aid – transfer payment from one level of government to another that does not involve compensation
Impact of government spending
- Subsidy – government payment to encourage or protect a certain economic activity
- Distribution of income – way in which the nation’s income is divided among families, individuals, or other designated groups
Section 10.2 – federal, state, and local government expenditures
- Federal budget – annual plan outlining proposed expenditures and anticipated revenues
Federal government expenditures
- Fiscal year – 12-month financial planning period that may not coincide with the calendar year
- The president’s budget proposes a request, which is sent to the congress for approval
- The budget will be broken down to 13 categories, which will also be sent to subcommittees
- Appropriations bills – legislation authorizing spending for certain purposes
- If approved, the bill will be sent to the president for signature
- Budget deficit – a negative balance after expenditures are subtracted from revenues
- Budget surplus – a positive balance after expenditures are subtracted from revenues
- Mandatory spending – federal spending authorized by law that continues without the need for annual approvals by congress
- Discretionary spending – spending for federal programs that must receive annual authorization
- Income security consists of a wide range of programs that includes retirement benefit for both federal civilian employees and retired military
- Medicare – federal health-care program for senior citizens, regardless of income
- Medicaid – joint federal state medical insurance program for low income people
- Interest on debt makes up the sixth largest category of federal spending
State government expenditures
- Balanced budget amendment – constitutional amendment requiring government to spend no more than it collects in taxes and other revenues, excluding borrowing
- Intergovernmental expenditures – funds that one level of government transfers to another level for spending
- Public welfare in forms of cash assistance, payments for medical care
- Insurance and retirement funds for state employees
Local government
- Power to approve spending rests with mayor, the city council, county judge, or some elected representative or body
- Revenues collected from property taxes, city income taxes, and other local sources
- Local government fund institutions, police force, and community workers
- Roads and highways are another expense for local government
10.3 – deficits, surpluses, and the national debt
From deficits to debt
- Deficit spending – annual government spending in excess of taxes and other revenues
- Depends on the way expenditures are reported and the state of economy
- Changes in economy affect budget projections (strong economic growth can cause the deficit to shrink due to the high tax collections and lower unemployment claims)
- National debt – total amount borrowed from investors to finance the government’s deficit spending
- Balanced budget – annual budget in which expenditures equal revenues
- Trust fund – special account used to hold revenues designated for a specific expenditure such as social security, Medicare, or highways
- Per capita – per person basis; total divided by population
- Private debt owed to others while national debt to ourselves
- Private borrowing usually makes plans to repay the debt; when government borrows, they issue new bonds to pay off the old bonds
- Private individuals give up purchasing power because they have less money to purchase
- Federal government does not give up purchasing power, because the taxes collected from some groups are simply transferred to other groups
Impact of the national debt
- National debt can cause a transfer of purchasing power from the private sector to the public sector
- Government can reduce economic incentives if it appears to spend money in a careless manner
- Federal government uses deficit spending, it must borrow money in financial markets; raises interest rates, forcing all borrowers to pay more for the temporary use of funds
- Crowding out effect – higher than normal interest rates and diminished access to financial capital faced by private borrowers when they compete with government borrowing in financial markets
- National debt and the tax structure can impact the distribution of income
Reducing deficits and the debt
- Balanced budget and emergency deficit control act of 1985 failed for two reasons
- Congress discovered that it could get around the law by passing spending bills that took effect two or three years later
- Economy started to decline in 1990, triggering a suspension of budget cuts when the economy was weak
- 1990 budget enforcement act (main feature below)
- Pay as you go provision – requirement that new spending proposals or tax cuts must be offset by reductions elsewhere
- Cutting spending was too difficult
- 1996, line item veto – power to cancel specific budget items without rejecting the entire budget
- Spending caps – limits on annual discretionary spending
- 1993 President Clinton”s omnibus budget reconciliation act attempted to trim $500 billion from deficit over 5 years
- Spending reduction with increase tax
- Entitlement – program or benefit using established eligibility requirements to provide health, nutritional, or income supplements to individuals
