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

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