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
author avatar
William Anderson (Schoolworkhelper Editorial Team)
William completed his Bachelor of Science and Master of Arts in 2013. He current serves as a lecturer, tutor and freelance writer. In his spare time, he enjoys reading, walking his dog and parasailing. Article last reviewed: 2022 | St. Rosemary Institution © 2010-2024 | Creative Commons 4.0

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